Strengthening the European Union Emissions Trading Scheme by Raising Climate Ambition. Facts

STRENGTHENING THE EUROPEAN UNION

EMISSIONS TRADING SCHEME

AND RAISING CLIMATE AMBITION

Facts, Measures and Implications

Report by Öko-Institut

Hauke Hermann, Felix Chr. Matthes

Öko-Institut (Institute for Applied Ecology) Strengthening the EU ETS

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Executive Summary

EU energy and climate policy faces manifold challenges. The debate on tougher emis-

sions reduction targets for 2020 is gaining momentum, the need for an integrated

framework and long-term targets as well as consistent and interim targets for 2020 and

2030 is becoming clear and adjustments to the EU’s Emissions Trading Scheme (EU

ETS) seem to be indispensable to preserve its role as a central pillar of the EU’s ener-

gy and climate policy mix.

The EU is very close to fulfilling its recent greenhouse gas emission commitments for

2020. Including the committed and projected use of external emissions reduction cred-

its, only a gap of three percentage points remains, which is theoretically already gap-

filled with the cap of the EU ETS by 2020. The current situation is also challenging for

the EU ETS, which is facing significantly falling allowance prices. The fundamental rea-

son for this price trend is the massive supply of EU emission allowances (EUA) and

emission reduction credits which exceeds the demand significantly. This surplus was

950 million EUA in 2011, will reach approx. 2 billion EUA in 2013 and still amount to 1.4

billion EUA in 2020. It results from huge entitlements for the use of external emission

reduction credits from CDM and JI and the long-term impacts of the economic crisis.

Only a minor contribution to the surplus results from the support for renewable energy

sources (RES) with complementary policies to the EU ETS because the recent growth

plans for RES match quite well with the assumptions made for cap-setting in 2008.

Two different approaches were used to analyse potential interventions and adjustments

of the EU ETS. Firstly, a set aside of 1,400 million allowances combined with a tighter

cap for the EU ETS by increasing the linear reduction factor from a recent 1.74 % to

2.25 % from 2014 onwards. Secondly, the adjustment of the linear reduction factor was

derived from more ambitious goals for the total domestic emission reductions. An in-

crease of the linear reduction factor from 1.74 % to 2.6 % would be consistent with a

25 % domestic emission reduction, compared to 1990, and a linear reduction factor of

3.9 % would refer to a domestic target of -30 %. The analysis clearly shows that a sig-

nificant and timely reduction of the surplus is only possible with the combination of a

set aside and adjustments of the cap by increasing the linear reduction factor. Stand-

alone measures like a set aside on the one hand or the adjustments of the linear reduc-

tion factor on the other hand will have only extremely limited impacts on the surplus for

the next decade. However, set asides will only have an impact if the market partici-

pants believe that the respective amount of allowances will be held back for a sufficient

period of time (at least a decade) or will be retired. Furthermore, tighter caps for the EU

ETS will only achieve the intended effects if they are not complemented by an increase

in the entitlements for the use of external credits.

An assessment of the different options with a relatively simple allowance price model

enables key lessons on different types of interventions to emerge:

A stand-alone approach for a set aside which will be fully reintroduced to the

market before 2020 will have negligible price effects. The EUA price would re-

main at a level of less than 8 €/EUA in 2013 and approx. 14 €/EUA in 2020.

Strengthening the EU ETS Öko-Institut (Institute for Applied Ecology)

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A set aside for a decade or longer will increase prices by about 2.50 €/EUA in

2013 and by about 4 €/EUA in 2020.

If the linear reduction factor is increased to 2.25 % alone, the price effect in

2013 would be very low (1 €/EUA) and slightly higher in 2020 (2 to 3 €/EUA).

If a long-term set aside is combined with a tighter linear reduction factor of

2.25 %, the price effects would be approx. 4.50 €/EUA for 2013 and about

15 €/EUA for 2020.

A tighter cap for aviation (applying the linear reduction factor of 2.25 % also to

the sub-cap for aviation) would further increase the EUA price by € 0.50.

The EUA price effects of a long-term set aside and an increase of the linear re-

duction factor to 2.6 % could increase the price in 2013 by about 5 €/EUA and

by up to 17 €/EUA in 2020.

The combination of a long-term set aside and an increase of the linear reduction

factor by 3.9 % would lift the EUA price by up to € 7 in 2013 and potentially and

with comparatively high uncertainties by more than € 20 by 2020.

Based on this analysis a set of four recommendations can be put forward for adjust-

ment of the EU ETS:

Firstly, a set aside can reduce the allowance surplus within the EU ETS in the

short term. However, the respective amount of allowances should be held back

for a period of a decade or more or retired at the earliest point in time.

Secondly, the long-term cap should be tightened by a significant increase of the

linear reduction factor, preferentially from 2014 onwards. The effective increase

is subject to fundamental political decisions on the overall emission reduction

targets. However, an increase of the linear reduction factor to less than 2.6 %

will be not consistent with overall targets of 25 % domestic emission reduction

and a factor of less than 3.9 % will not be consistent with an overarching target

of 30 % domestic action by 2020.

Thirdly, no additional entitlements for the use of external emission reduction

credits should be created in the process of tightening the EU ETS cap.

Fourthly, the implementation of high impact complementary policies (e.g. the

impact of the upcoming Energy Efficiency Directive on emissions in the EU ETS

sectors), a long-lasting change in fundamental drivers for baseline emissions

(e.g. a significantly lower economic growth for a longer period) or other changes

in the regulatory framework (e.g. the discontinuation of significant parts of the

aviation sector as net buyers in the market) should be reflected by a strictly

rule-based and high-threshold provision to lower the cap in the EU ETS.

These kinds of structural improvements could help to preserve the key role of the EU

ETS in an enabling policy mix for ambitious, effective and efficient climate policy.


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Zusammenfassung

Die Energie- und Klimapolitik der Europäischen Union steht vor vielfältigen Herausfor-

derungen. Mit zunehmender Intensität werden ambitionierte Emissionsreduktionsziele

für 2020 diskutiert, die Notwendigkeit eines integrierten Ansatzes und langfristiger Kli-

maschutzziele sowie damit konsistenter Zwischenziele für 2020 und 2030 werden im-

mer deutlicher. Gleichzeitig erscheinen Veränderungen am Emissionshandelssystem

der Europäischen Union (EU ETS) unabdingbar, wenn dieses Instrument seine Rolle

als zentrales Element im Portfolio der europäischen Energie- und Klimapolitik behalten

soll.

Die bisherigen Treibhausgas-Emissionsminderungsziele für das Jahr 2020 hat die EU

bereits sehr weitgehend erfüllt. Unter Berücksichtigung der bereits realisierten und er-

wartbaren Minderungsgutschriften aus externen Projekten verbleibt nur noch eine Ziel-

erreichungslücke von etwa 3 Prozentpunkten, die faktisch durch das feste Emissions-

ziel des EU ETS bereits geschlossen ist. Aus dieser aktuellen Situation entsteht jedoch

für das EU ETS eine durchaus problematische Situation, vor allem angesichts massiv

zurückgehender Preise für die Emissionsberechtigungen des EU ETS (European Uni-

on Allowances – EUA). Fundamental sind diese Preisentwicklungen durch das sehr

große Angebot an Emissionsberechtigungen und externen Minderungsgutschriften

erklärbar, das den Bedarf erheblich überschreitet. Dieser Überschuss belief sich auf

950 Millionen EUA im Jahr 2011, wird bis 2013 auf etwa 2 Milliarden EUA ansteigen

und im Jahr 2020 immer noch 1,4 Milliarden EUS betragen. Hauptgründe dafür sind die

umfangreich zugelassene Nutzung externer Emissionsminderungsgutschriften aus

dem Clean Development Mechanism (CDM) und Joint Implementation (JI) sowie die

längerfristigen Auswirkungen der Finanz- und Wirtschaftskrise. Eine nur untergeordne-

te Rolle spielt dagegen der Überschuss, der sich aus der Förderung erneuerbarer

Energien mit Instrumenten jenseits des EU ETS ergibt, entsprechen doch die aktuellen

Ausbaupläne für erneuerbare Energien vergleichsweise gut den Annahmen, die im

Jahr 2008 bei der Festlegung des Emissionsziels für den EU ETS (Cap) getroffen wur-

den.

Die Analyse unterschiedlicher Veränderungen bzw. Anpassungen des EU ETS erfolgte

aus zwei unterschiedlichen Perspektiven. Erstens wurde die Herausnahme (Set aside)

von 1,4 Milliarden EUA aus dem EU ETS in Kombination mit einem ambitionierteren

Cap untersucht, die sich aus einer Erhöhung des linearen Reduktionsfaktors von bisher

1,74 % auf 2,25 % ab 2014 ergibt. Zweitens wurden Anpassungen des linearen Reduk-

tionsfaktors aus stärkeren Minderungszielen für die Gesamtemissionen der EU abge-

leitet. Eine ausschließlich in der EU erbrachte Emissionsminderung von 25 % gegen-

über 1990 entspricht dabei einer Erhöhung des linearen Reduktionsfaktors von 1,74

auf 2,6 %, eine Erhöhung des entsprechenden Ziels auf -30% wäre konsistent mit ei-

nem Anstieg des linearen Reduktionsfaktors auf jährlich 3,9 %. Die Analysen verdeutli-

chen, dass eine maßgebliche und rechtzeitige Rückführung des Überschusses an

Emissionsrechten nur mit der Kombination eines Set aside und einer Anpassung des

Caps mittels Verschärfung des linearen Reduktionsfaktors erreicht werden können.


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Isolierte Ansätze wie ein Set aside für sich oder die Anpassung des linearen Redukti-

onsfaktors allein haben dagegen für die nächste Dekade nur sehr begrenzte Wirkun-

gen auf die Entwicklung des Überschusses an Emissionsberechtigungen. Dessen un-

geachtet kann ein Set aside nur dann eine Wirkung entfalten, wenn die Marktteilneh-

mer zu der Einschätzung gelangen, dass die entsprechenden Zertifikatsmengen für

einen ausreichend langen Zeitraum (mindestens eine Dekade) aus dem Markt ge-

nommen oder stillgelegt werden. Darüber hinaus werden verschärfte Caps im EU ETS

nur dann die intendierten Effekte zeitigen, wenn sie nicht mit einer Erhöhung der Nut-

zungsberechtigungen für externe Emissionsminderungsgutschriften einhergehen.

Die Bewertung der unterschiedlichen Modelle mit einem vergleichsweise einfachen

Modell zur Abschätzung von Preisen für Emissionsberechtigungen führt zu folgenden

zentralen Ergebnissen:

Ein Set aside ohne weitere Ergänzungen, das vor 2020 wieder vollständig dem

Markt zur Verfügung gestellt wird, hat nur vernachlässigbare Effekte auf den

Preis für Emissionsberechtigungen. Der Preis für Emissionsberechtigungen

würde auf einem Niveau von unter 8 €/EUA im Jahr 2013 und ungefähr

14 €/EUA im Jahr 2020 verbleiben.

Ein Set aside, das für eine Dekade oder länger aus dem Markt genommen wird,

erhöht die Zertifikatspreise um etwa 2,50 €/EUA im Jahr 2013 und ungefähr

4 €/EUA in 2020.

Wenn nur der lineare Reduktionsfaktor auf 2,25 % erhöht wird, ergibt sich für

das Jahr 2013 nur ein geringfügiger Preiseffekt (1 €/EUA) und für 2020 eine et-

was größere Zertifikatspreiserhöhung (2 bis 3 €/EUA).

Wenn ein längerfristig angelegtes Set aside mit einem verschärften linearen

Reduktionsfaktor von 2,25 % kombiniert wird, so ergeben sich Preiserhöhungen

von etwa 4.50 €/EUA für 2013 und ungefähr 15 €/EUA für 2020.

Ein ambitioniertes Cap für den Flugverkehr (über die Anwendung des linearen

Reduktionsfaktors von 2,25 % auch für diesen Teil des EU ETS) würde den

EUA-Preis um weitere 0,50 € erhöhen.

Als Effekt eines längerfristig angelegten Set aside in Kombination mit einer Er-

höhung des linearen Reduktionsfaktors auf 2,6 % könnte sich der Zertifikats-

preis im Jahr 2013 um 5 €/EUA und um bis zu 17 €/EUA im Jahr 2020 erhöhen.

Das Zusammenwirken eines längerfristig angelegten Set aside und einer Ver-

schärfung des linearen Reduktionsfaktors auf 3,9 % würde die EUA-Preise in

2013 um etwa 7 € und bis 2020 – bei vergleichsweise hohen Unsicherheiten –

um mehr als 20 € erhöhen.

Auf der Grundlage dieser Analysen ergeben sich für das EU ETS insgesamt vier Emp-

fehlungen:

Erstens kann mit einem Set aside der Zertifikatsüberschuss im EU ETS kurzfris-

tig reduziert werden. Die entsprechende Menge an Emissionsberechtigungen


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sollte jedoch für eine Dekade oder mehr zurückgehalten oder frühestmöglich

stillgelegt werden.

Zweitens sollte das langfristige Cap über eine deutliche Erhöhung des linearen

Reduktionsfaktors verschärft werden, die vorzugsweise ab 2014 wirksam wer-

den sollte. Das Ausmaß dieser Erhöhung resultiert aus grundlegenden politi-

schen Entscheidungen zum übergeordneten Minderungsziel für die gesamten

Treibhausgasemissionen. Eine Erhöhung des linearen Reduktionsfaktors von

weniger als 2,6 % wäre jedoch nicht konsistent zu einem Minderungsziel für die

Emissionen in der EU von 25 %, eine Erhöhung um weniger als 3,9 % wäre

nicht konsistent mit einem Ziel für Emissionsminderungen in der EU von 30%

bis zum Jahr 2020.

Drittens sollten die Budgets für die Nutzung externer Emissionsminderungsgut-

schriften im Zuge einer Verschärfung des Caps für den EU ETS nicht erhöht

werden.

Viertens sollte die Umsetzung von zusätzlichen Politiken und Maßnahmen mit

weitreichenden Emissionsminderungswirkungen (z.B. die anstehende EU-

Richtlinie zur Energieeffizienz) sowie langfristig wirksame Veränderungen ent-

scheidender Treibergrößen für die Referenzentwicklung bei den Emissionen

(z.B. ein längerfristig deutlich verringertes Wirtschaftswachstum) oder andere

Änderungen (die z.B. den Wegfall eines Teils der Nachfrage aus dem Flugver-

kehr bewirken könnten) über eine entsprechende Eingriffsregelung für eine Ver-

ringerung des Caps berücksichtigt werden, die jedoch strikt regelbasiert sowie

mit hohen Eingriffsschwellen ausgestaltet werden sollte.

Solcherart ausgestaltete, strukturellen Verbesserungen könnten dazu beigetragen, die

Schlüsselrolle des EU ETS in einem nachhaltigen Portfolio ambitionierter, effektiver

und effizienter Klimapolitik zu bewahren.


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Contents

Executive Summary .................................................................................................................... 3

Zusammenfassung ...................................................................................................................... 5

1 Introduction, scope and structure of the analysis ......................................................... 13

2 Trends and targets for the greenhouse gas emissions of the EU ................................ 16

2.1 Trends and targets for total greenhouse gas emissions of the EU .......................................... 16

2.2 Cap under the EU ETS from 2005 to 2020 and beyond .......................................................... 18

3 The recent problem: Allowance surplus from 2008 to 2011 .......................................... 23

3.1 Introduction, scope and structure of the analysis .................................................................... 23

3.2 Trend of verified emissions in the EU ETS for 2008 to 2011 ................................................... 23

3.3 Free allocation for 2008 to 2011 .............................................................................................. 24

3.4 Auctions and sales for 2008 to 2011 ....................................................................................... 24

3.5 Use of CDM and JI credits from 2008 to 2011 ........................................................................ 24

3.6 Demand and supply balance for 2008 to 2011 ........................................................................ 24

4 The future challenge: Projection for the EU ETS surplus until 2020 ........................... 26

4.1 Introduction, scope and structure of the analysis .................................................................... 26

4.2 Baseline emission trends for the EU ETS from 2012 to 2030 ................................................. 26

4.3 Free allocation from 2012 to 2020 ........................................................................................... 33

4.4 Auctions and sales from 2012 to 2020 .................................................................................... 34

4.5 Use of CDM and JI credits from 2012 to 2020 ........................................................................ 35

4.6 New entrant reserve for the second trading period ................................................................. 38

4.7 Total supply and demand balance for 2012 to 2020 ............................................................... 39

5 Interim summary: Demand and supply balance 2008 to 2020 ...................................... 41

6 Analysis of current proposals for intervention .............................................................. 44

6.1 Introduction, overview and structure of the analysis ................................................................ 44

6.2 Specification of the options for the analysis ............................................................................ 45

6.3 Reduction of the surplus in the EU ETS .................................................................................. 48

6.4 Potential range of price effects ................................................................................................ 50

6.4.1 Methodological approach .......................................................................................... 50

6.4.2 Results of the allowance price effects estimates ....................................................... 55

7 More ambitious greenhouse gas emission reduction targets for the EU:

Analysis of implications for the EU ETS ......................................................................... 57

8 Summary and conclusions ............................................................................................... 63

9 References ......................................................................................................................... 67


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List of tables

Table 1 Cap references for the second trading period of the EU ETS ........... 18

Table 2 Comparison of approaches to quantify the cap for the third trading period of the EU ETS (scope of the second period), 2013-2020 ......................................................................................... 20

Table 3 Cap for the EU ETS in the third trading period, 2013-2020 .............. 21

Table 4 Surplus of allowances in the EU ETS, 2008-2011 ............................ 25

Table 5 Updated baseline emission trends for the EU ETS sectors, 2005-2030 ......................................................................................... 33

Table 6 Amount of free allocation, 2008-2020 ............................................... 33

Table 7 Amount of free allocation from the new entrant reserve, 2013-2020 ......................................................................................... 34

Table 8 Amount of allowance auctions and sales, 2008-2020 ....................... 35

Table 9 Entitlements for the use of CDM and JI credits for operating installations from the EU ETS scope II, 2008-2020 .......................... 36

Table 10 Total entitlements for the use of CDM and JI credits, 2008-2020 .................................................................................................. 38

Table 11 Comparison of cap, free allocation, auctions and sales, 2008-2012 ......................................................................................... 38

Table 12 Demand and supply balance, 2012-2020 ......................................... 39

Table 13 Demand and supply balance for the second and third trading period, 2008-2020 ............................................................................. 41

Table 14 Additional reduction efforts resulting from different options to reduce the surplus in the EU ETS, 2013-2030 ................................. 47

Table 15 Projection for the supply of Certified Emission Reductions (CERs) eligible under EU ETS rules from 2013 to 2020 ................... 52

Table 16 Allowance price projections for the EU ETS from the EU Energy Roadmap 2050, 2020-2040 .................................................. 53

Table 17 CO2 allowance price effects of the different options, 2013 and 2020 ........................................................................................... 55

Table 18 Key implications for the EU ETS from the back-casting calculations for the 25 % and 30 % domestic reduction targets by 2020 ................................................................................. 62


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List of figures

Figure 1 Total greenhouse gas emission trends and goals for the European Union (excluding LULUCF and including international aviation), 1990-2050 ..................................................... 17

Figure 2 Evolution of the caps for the EU ETS, 2005-2050 ............................ 22

Figure 3 Comparison of GDP projections for ETS-relevant modelling exercises for the European Union, 2005-2030 ................................. 27

Figure 4 Comparison of CO2 emission abatement contributions from renewable energy sources in the power sector for the EU, 2005-2020 ......................................................................................... 29

Figure 5 Update of the baseline projection for the EU ETS (scope of the second trading period), 2020 ...................................................... 30

Figure 6 Comparison of historical CO2 emissions data and baseline projections for the EU ETS (scope of the second period and aviation), 2005-2030 ......................................................................... 31

Figure 7 Evolution of the surplus in the EU ETS, 2008-2020 .......................... 42

Figure 8 Comparison of the effects of different options to reintroduce the set aside on the surplus in the EU ETS at a cap level based on the linear reduction factor of 1.74 %, 2013 to 2030 .......... 48

Figure 9 Comparison of the effects of options to implement an increased linear reduction factor on the surplus in the EU ETS, 2013 to 2030 ............................................................................ 49

Figure 10 Price trends for European Union Allowances (EUA) and EUA-CER spreads, 2003-2012 ......................................................... 50

Figure 11 Discounted CO2 allowance prices for different periods of oversupply......................................................................................... 54

Figure 12 Total and domestic emission reductions according to the 2008 Climate and Energy Package, 2020 ........................................ 58

Figure 13 Adjustments of the ETS and the switch to more ambitious EU targets for greenhouse gas emission reductions in 2020 ........... 60


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1 Introduction, scope and structure of the analysis

The climate and energy policy of the European Union (EU) and its Member States is

framed by the energy and climate package of 2008 which includes a set of binding tar-

gets for greenhouse gas emission reductions and the deployment of renewable energy

sources and a broad range of respective policies and measures. However, the Europe-

an climate and energy policy faces a series of challenges:

The EU has made significant progress towards meeting its unilaterally envis-

aged target of 20 % greenhouse gas reduction for the period from 1990 to

2020. However, the broad range of domestic action in many countries world-

wide, among them some important emerging countries (China, India, Brazil,

South Africa etc.) as well as key OECD countries (parts of the USA, Australia,

South Korea, Mexico etc.) challenge to the EU to tighten its emission reduction

efforts.

Due to several factors the greenhouse gas-based European Union Emissions

Trading Scheme (EU ETS) faces serious challenges in terms of its role as a

central and EU-wide pillar of the EU’s climate policy mix. The significant drop in

emission allowance prices and the obvious lack of scarcity in the market create

a need for appropriate action.

The EU ETS is thus at the core of a debate on the wider topic of future emissions re-

duction efforts of the EU (which are significantly framed by the EU ETS) as well as on

the EU ETS as a key economic instrument which combines environmental effective-

ness and economic efficiency:

The EU ETS generates a price on carbon dioxide (CO2) and other greenhouse

gases released into the atmosphere by the regulated entities. The market-

based price discovery for the costs of emission abatement creates a dynamic

long-term framework for emission reductions in the regulated sectors.

The EU ETS creates an extremely transparent quantitative framework for long-

term emission reduction strategies. The cap and its development over time

without a sunset clause provides clear signals for policy makers, the regulated

entities and the public of the trajectory of emissions and the contribution to

emission reduction that will be delivered by the regulated sectors.

The EU ETS will generate significant revenue streams after the main allocation

mechanisms of the scheme are shifted to the auctioning of allowances from

2013 onwards. Significant parts of these revenue streams should be available

for national, European and international climate financing.

This threefold role of the EU ETS should also be considered in the framework of the

recent challenges to the EU ETS.

After the significant price drop of CO2 allowances within the EU ETS (European

Union Allowances – EUA) after the financial and economic crisis, the price sig-

nal from the EU ETS no longer delivers sufficient price signals for investments


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in low-carbon technologies. Given the emerging re-investment cycle for sectors

with long-lasting capital stocks (e.g. the power sector) this creates a major chal-

lenge for the EU ETS because of a risk of lock-in into CO2-intensive infrastruc-

tures.

The contributions of the EU ETS to climate financing will be much less signifi-

cant than originally assumed. This creates a problem for specific support pro-

grammes set up by the European Union (e.g. the financing of innovative tech-

nologies from the auctioning of 300 million allowances from the new entrants

reserve) as well as the wide range of climate financing efforts by the Member

States (e.g. the national and the international climate initiative from the German

energy and climate fund which will absorb fully the revenues from allowance

auctions in Germany).

The recent trajectory for the cap of the EU ETS is not fully consistent with the

long-term emission target of the EU to reduce greenhouse gas emissions by 80

to 95 % by the middle of this century, compared to 1990 levels, as well as con-

sistent interim emission reduction targets for 2020 and 2030, e.g. 30 % and

55 %, respectively. Furthermore, the emission reduction pathway of the EU

ETS is subject to change if the EU needs to increase its efforts in the context of

the activities abroad (which often include the set-up of EU ETS-like mecha-

nisms and underline the important function of the EU ETS as a role model).

After eight years of operation (2005-2012) and even after a major re-adjustment for the

trading periods from 2013 onwards, the EU ETS faces an emerging debate on how to

fix the problems mentioned above. However, these debates should reflect different

dimensions which interact with each other:

What are the main drivers for the recent problems that the EU ETS is facing?

What are the options for addressing these problems, which effects would these

options have over time and how could these options fit into the needs for ad-

justments of the overall climate policy framework?

The analysis presented in this study is based on a detailed analysis of a range of is-

sues, which are related to the two questions specified above:

In chapter 2 the most recent trends as well as the targets for total greenhouse

gas emissions and the evolution of the long-term cap for the EU ETS are de-

scribed in some detail.

Chapter 3 deals with the supply and demand for emission allowances and offset

credits in the first four years of the recent trading period and specifies the bal-

ance between demand and supply based on historical data.

In chapter 4 a comprehensive analysis is presented on the demand and supply

of allowances for the remaining year of the second period and the upcoming

third period up to 2020.


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Chapter 5 summarizes the demand and supply situation for the whole period

from 2008 to 2020 and specifies the main sources for the surplus of emissions

allowances by 2020.

Chapter 6 presents the analysis of some options for adjustments of the EU ETS

to address the key challenges for the next decade, including the effects on al-

lowance prices which can be assumed. The starting points for this analysis are

prominent political proposals taken from the recent debates on the EU ETS.

In chapter 7 the approaches to addressing the specific EU ETS challenges are

set into context with tightened overall emission reduction targets for the Euro-

pean Union by 2020 and beyond. These proposals on adjustments for the EU

ETS are derived from ambitious greenhouse gas reduction targets for domestic

action by 2020 based on a back-casting approach.

Chapter 8 provides a series of conclusions derived from the quantitative and

qualitative analysis.

It should be highlighted that the analysis is focused on key issues of demand and sup-

ply of allowances in a longer-term perspective.

Broader options for approaching the EU ETS, like active price management

based on price floors or price corridors or a carbon market version of open mar-

ket policy (Grubb 2012, Perthuis/Trotignon 2012) are explicitly not subject to the

analysis presented in this study.

Within the framework of a more ambitious climate policy, broader approaches in

terms of appropriate targets as well as policies and measures will be necessary.

This is relevant for policies and measures beyond the EU ETS as well as for

policies and measures addressing sectors which are not regulated by the EU

ETS. These issues are not covered by the scope of the analysis presented in

this paper.

Last but not least, the issues handled in this paper are highly political and at the same

time highly technical ones. This tension creates a strong need for transparency. There-

fore the analysis and documentation presented in this paper has a two-fold purpose.

Firstly, the information should be usable as a compendium for key data and data links

which are important to navigate across the debates. Secondly, the findings should sup-

port specific action and thus be as explicit as possible.

The authors benefitted enormously from a broad range of discussions with many col-

leagues and partners and wish to thank them for this. This paper has been edited by

Vanessa Cook (Öko-Institut). However, any errors or inaccuracies remain the sole re-

sponsibility of the authors.


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2 Trends and targets for the greenhouse gas emissions of

the EU

2.1 Trends and targets for total greenhouse gas emissions of the EU

The historical trends for greenhouse gas emissions of the European Union (27 Member

States) are characterized by three phases (Figure 1)1:

In the early 1990s the greenhouse gas emissions decreased significantly, main-

ly due to the transformation process in Eastern Germany and the Member

States who entered the EU in 2005 and 2007 (new Member States) and mainly

in sectors which have been regulated by the EU ETS since 2005. From 1990 to

1995 the emissions decreased by approx. 6 %.

During the period from 1995 to 2005 the emissions at the aggregate level tend

to stagnation or a slight decrease but indicate different sectoral patterns. For

the sectors regulated later under the EU ETS (power sector, energy intensive

industries) a slight increase occurred, the emissions from aviation increased

significantly and the emissions from the non-ETS sectors decreased. For the

whole period from 1990 to 2005 the total greenhouse gas emissions reduction

amounted to 7 %.

From 2005 the emissions drop significantly, in the first years exclusively from

non-ETS sectors and from 2008 dominantly in the ETS-regulated sectors

whereas the latter trend was obviously but not exclusively triggered by the fi-

nancial and economic crisis from 2008 onwards. In 2009 the total emissions re-

duction compared to 1990 reached 16 %, in 2010 the respective level was 14 %

below 1990 levels.

The EU ETS for stationary installations represents (at the scope of the scheme from

2013 onwards) a share of 42 - 45 % in the total greenhouse gas emissions, the inclu-

sion of the aviation sector (from 2012 onwards) increases this share to 45 - 48 %. The

European Union has defined a set of greenhouse gas reduction targets for different

time horizons:

1 For the purpose of consistency with the ETS-related analysis the quantitative analysis of

greenhouse gas emission trends includes the emissions from international aviation (which is not accounted for under the provisions of the Kyoto Protocol to the United Nations Frame-work Convention on Climate Change (UNFCCC) but excludes the emissions from land use, land use change and forestry (LULUCF)). However, it should be pointed out that the scope of the greenhouse gas inventories under the UNFCCC covers the fuel deliveries to aircrafts and differs from the emission accounting for aviation under the EU ETS. In order to make these two data sets compatible, relative change rates were applied when certain trends or patterns from the one database had to be transferred to the other one.


- 17 -

For 2020 the EU has committed itself to an emission reduction of 20 % below

1990 levels on a unilateral basis (CEU 2007, EU 2009a, EU 2009b). An in-

crease of the ambition level to 30 % is a subject of recent debate.

No formal commitment of the EU exists yet for 2030. However, the range from

40 to 55 % is discussed within the scope of debates surrounding the Low-

Carbon Economy Roadmap and the Energy Roadmap 2050 (CEC 2011d, CEC

2011e, Öko-Institut 2011).

The EU declared and re-affirmed on several occasions a long-term emission

reduction target of 80 to 95 % below 1990 levels by 2050 (CEU 2010, CEU

2011, EP 2010).

Figure 1 Total greenhouse gas emission trends and goals for the European Union

(excluding LULUCF and including international aviation), 1990-2050

0

1,000

2,000

3,000

4,000

5,000

6,000

1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

mln

t C

O2

e

Aviation (national &international)

Non-ETS sectors

EU ETS (proxy datafrom 1990 to 2004)

2020 Goal-20...-30%compared to 1990

2030 Goal-40...-55%compared to 1990

2050 Goal-80...-95%

compared to 1990

Source: UNFCCC, European Commission, calculations by Öko-Institut

The comparison of the historical emission patterns (Figure 1) and the medium- and

long-term emission reduction targets highlights on the one hand that the sectors regu-

lated by the EU ETS must deliver a significant share of the required reduction efforts.

On the other hand the general trajectory towards the long-term targets is not fully con-

sistent with the 2020 targets as defined and addressed in recent debates. Given the

fact that the EU ETS is essentially parameterized in the framework of the 20 % emis-

sions reduction target for 2020 (as laid down in the energy and climate package of

2008) it will potentially require adjustments to maintain the appropriate investments,

which fit into the long-term trajectory towards an 80 to 95 % emission reduction by

2050.


- 18 -

2.2 Cap under the EU ETS from 2005 to 2020 and beyond

The emissions target of the EU ETS – the cap – is determined by the total amount of

allowances (European Union allowances – EUA) which are available to the regulated

entities either from free allocation or purchases or auctions. However, for the second

period of the EU ETS the exact number of these allowances is subject to changes, de-

pending on the decisions on the National Allocation Plans (NAP) of the Member States

which form as a total the EU-wide cap for the second period from 2008 to 2012.

Table 1 Cap references for the second trading period of the EU ETS

NAP decisions

(2006/2007)

NAP table decisions

(2008, 2009, 2010)

CITL "NAP Info"

(2012)

Austria 30.70 30.73 30.96

Belgium 58.50 58.49 58.49

Bulgaria 42.30 38.09 39.29

Cyprus 5.48 5.25 5.35

Czech Republic 86.80 86.74 86.74

Denmark 24.50 24.50 24.50

Estonia 12.72 13.10 13.10

Finland 37.60 37.56 37.56

France 132.80 131.99 134.37

Germany 453.10 451.47 452.34

Greece 69.10 68.31 68.31

Hungary 26.90 26.65 26.65

Ireland 22.30 22.28 22.29

Italy 195.80 201.59 201.59

Latvia 3.43 3.41 6.25

Liechtenstein 0.00 0.02 0.02

Lithuania 8.80 8.58 8.58

Luxembourg 2.50 2.49 2.49

Malta 2.10 2.14 2.14

Netherlands 85.80 87.47 87.47

Norway 15.05 15.05 15.05

Poland 208.50 205.70 205.70

Portugal 34.80 34.81 34.81

Romania 75.90 74.06 74.05

Slovakia 30.90 32.54 32.54

Slovenia 8.30 8.30 8.29

Spain 152.30 152.25 152.25

Sweden 22.80 22.47 22.47

United Kingdom 246.20 245.62 245.62

EU-27 2080.93 2076.60 2084.21

All EU ETS countries 2095.98 2091.66 2099.28

mln EUA

Note: The cap for Austria was corrected downwards for the allowances purchased by the Austrian government to

replenish the new entrant reserve and that are included in the NAP table decision and the CITL “NAP Info” for

Austria. Reserves for the use of emissions reduction credits from Joint Implementation are not taken into account

when calculating the caps. The total for all EU ETS countries includes Norway and Liechtenstein.

Source: NAP decisions2, NAP table decisions

3, CITL “NAP Info”

4, calculations by Öko-Institut

2 http://ec.europa.eu/clima/policies/ets/allocation/2008/documentation_en.htm.

3 http://ec.europa.eu/clima/policies/ets/registries/documentation_en.htm.


- 19 -

Table 1 summarizes the evolution of the cap in the EU ETS over time, which is charac-

terized by a slightly increasing trend. Based on the NAP decisions by the European

Commission in 2006/2007, the total of the national caps for the participating states

amounted to 2,096 million EUA. Based on the respective decisions on the so-called

NAP tables submitted by Member States in the years 2008 to 2010 (containing individ-

ual allocations for each installation) the total quantity slightly decreased to 2,092 million

EUA. However, over time the cap for the EU ETS undergoes further changes which are

documented in the Community Independent Transaction Log (CITL). As of May 2012

the exact cap amounted to 2,099 million EUA. The main reason for this increase is that

the cap of Latvia has doubled to 6 million EUA annually, according to the most recent

changes in the CITL (Table 1).5 The methodology and the transparency on the cap of

the EU ETS will increase significantly from 2013 onwards because the total cap will no

longer result from decentralized cap-setting in National Allocation Plans by the partici-

pating countries. From the start of the second trading period (2008-2012) the EU-wide

cap is centrally set by European legislation. This new cap-setting approach is based on

the EU-wide cap for the second period (expressed as the annual average of the re-

spective number of allowances) and a linear reduction factor (LRF). The linear reduc-

tion factor is applied to the cap level at the midpoint of the second trading period to

calculate a fixed number of allowances which is annually deducted from the cap for the

previous year. This annual deduction is also applied mathematically for the second half

of the second trading period but first takes effect in 2013. It is worth mentioning that the

EU ETS Directive as the legislative basis for the EU ETS does not specify any endpoint

for the application of the linear reduction factor and the linear reduction factor provides

long-term visibility of the emission reduction targets to be implemented by the EU ETS.

Although this general approach is complemented by some special provisions, e.g. for

installations which fall under the scope of the EU ETS from the beginning of the third

trading period, the transparency of the cap should significantly increase from 2013 on-

wards because the European Commission has to explicitly publish the respective cap

amounts.

For the analysis presented in this paper, the following approach was taken to specify

the cap: In order to not overestimate the cap from 2013 onwards the quantity of EUAs

stated in the NAP table decisions are taken as the average cap in the second trading

period of the EU ETS. This cap is reduced annually by a fixed amount of allowances

consistent to the linear reduction factor of 1.74 % annually in accordance with recent

4 CITL; Nap Info; Search; Country; First Commitment Period; History of the NAP; Total in

NAP. http://ec.europa.eu/environment/ets/napMgt.do?languageCode=en. 5 However, the total cap derived from the CITL data is likely to overestimate the cap because

in some cases governments (e.g. in Austria) bought allowances from the market to replenish the reserve for the free allocation to new entrants (new entrant reserve). In this case the EUAs are recorded twice in the CITL. On the one hand allowances are accounted for when they are initially issued (or auctioned/sold); on the other hand the allowances are recorded in the CITL when they are bought by governments and are issued to new entrants.


- 20 -

legislation. The respective cap from 2013 onwards has been published by DG Clima

(CEC 2010c and CEC 2010d) but it is important to note that this cap-setting is not the

final one. The most recent calculation of the cap (CEC 2010d) does not include allow-

ances from new entrant reserves that have not yet been allocated. This means that the

cap level published up to now is a preliminary one and it is very likely that it will be in-

creased in order to take into account allocations or auctions and sales from new en-

trant reserves.

Table 2 Comparison of approaches to quantify the cap for the third trading period

of the EU ETS (scope of the second period), 2013-2020

Total

average 2013 2014 2015 2016 2017 2018 2019 2020 2013-2020

Cap decision 2,039 1,932 1,897 1,861 1,826 1,790 1,755 1,719 1,684 14,464

Own calculation 2,077 1,968 1,932 1,896 1,860 1,824 1,788 1,751 1,715 14,734

Difference 38 36 35 35 34 33 33 32 31 269

2nd period 3rd trading period

Note: Own caculation is based on CITL data.

mln EUA

Source: CEC (2010b+d), calculations by Öko-Institut

Table 2 compares the cap from 2013 onwards for installations that already participated

in the second trading period (EU ETS II scope), including installations that opted-in to

the EU ETS in the second period (not including EUAs attributed to the non-EU coun-

tries Norway and Liechtenstein). The data compilation illustrates that compared to the

most recent cap decision it is likely that the final cap for the second and third trading

periods will increase by up to 38 million EUA per year.

Table 3 indicates the cap data estimates for the EU ETS from 2013 onwards which

were used for the analysis. It should be highlighted that the analysis must reflect the

fact that the scope of the EU ETS changes over time (increasingly broadening the

scope of stationary sources as well as the inclusion of new sectors like aviation). In

detail the cap estimates are based on the following data and assumptions:

The cap data for stationary installations already participating in the second trad-

ing period from 2008 to 2012 (Stationary ETS II scope) are taken from Table 2

(the “own calculation” column).

The quantity of allowances available for stationary installations participating

from the third trading period onwards (Stationary ETS III scope) is based on

CEC (2010d).

The quantity of allowances available for Norway and Liechtenstein is based on

a multiplication of the linear factor and the cap for the second trading period as

documented in Table 1.

The cap for aviation (which is included in the EU ETS from 2012 onwards) is

based on EEA JC (2011) and includes flights starting from or landing in the EU-

27, Iceland, Norway and Liechtenstein. It should be noted that the sub-cap for


- 21 -

aviation is not subject to an annual adjustment by the linear reduction factor and

remains constant in accordance with recent legislation.

Table 3 Cap for the EU ETS in the third trading period, 2013-2020

Total

2013 2014 2015 2016 2017 2018 2019 2020 2013-2020

Stationary ETS II scope 1,968 1,932 1,896 1,860 1,824 1,788 1,751 1,715 14,734

Stationary ETS III scope 106 104 102 100 98 96 94 92 794

Norway & Liechtenstein 14 14 14 13 13 13 13 12 107

Aviation 210 210 210 210 210 210 210 210 1,683

Total 2,299 2,260 2,222 2,184 2,145 2,107 2,069 2,030 17,317

3rd trading period

Note: The data for the stationary ETS scopes II and III reflect installations in EU-27 countries only.

mln. EUA

Source: CEC (2010d), EEA JC (2011), calculations by Öko-Institut

Figure 2 illustrates the implicit long-term reduction targets resulting from the cap-setting

approaches for the first, the second, the third and the subsequent trading periods:

The first trading period (2005-2007) is characterized by comparatively high caps

and the expansion of the scheme to include Romania and Bulgaria in 2007.

However, the cap for the first trading period exceeded the verified emissions

from the regulated installations significantly.

The second trading period (2008-2012) is characterized by the inclusion of addi-

tional installations as well as Norway and Liechtenstein on the one hand and a

significantly tightened cap on the other hand. Compared to the scope-adjusted

emissions for 2005 the cap represents an emission reduction of approx. 6 %.

The third and the subsequent trading periods are again characterized by a

broadened scope for the stationary installations as well as the inclusion of avia-

tion (from 2012 onwards). For the stationary ETS III scope the scope-adjusted

emission reduction compared to 2005 amounts to 21.5 % for 2020, 38 % for

2030 and 71 % for 2050. However, if the non-decreasing sub-cap for the avia-

tion sector is taken into account (the cap for aviation is set at a level of 95 % of

the 2004/2006 average emissions from 2013 onwards), the total reduction of

EU ETS-regulated and scope-adjusted emissions compared to 2005 is 20 % for

2020, 35 % for 2030 and 65 % for 2050.

Furthermore, the recent legislation foresees a sub-cap for free allocation to sta-

tionary sources in the EU ETS which should not exceed the share in emissions

from installations which are not subject to full auctioning from 2013 onwards.

However, if the emission reduction contributions from the EU ETS are seen in

context with the medium- and long-term minimum emission reduction goals for

the European Union (20 or more by 2020, 80 or more by 2050) the long-term

consistency of the recent linear reduction factor must be questioned: In the

framework of a total 20 % emissions reduction by 2020, compared to 1990, the

stationary installations regulated by the EU ETS would deliver about 66 % of


- 22 -

the total required emissions reduction from 2005 to 2020. Aviation would deliver

about 1 % and the non-ETS sectors 33 %.

For an 80 % emission reduction by 2050 the EU ETS would deliver only 40 % of

the necessary emission reduction from 2005 to 2050. If the 2020 target would

be tightened to 30 % and the cap of the EU ETS, i.e. the linear reduction factor

would not be subject to change, the EU ETS would only deliver about 38 % of

the necessary emission reduction. Aviation would contribute less than 1 % and

the non-ETS sectors 60 % of the total emission reduction.

Figure 2 Evolution of the caps for the EU ETS, 2005-2050

0

500

1,000

1,500

2,000

2,500

3,000

2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

mln

EU

A

EU ETS cap 1st period

EU ETS cap 2nd period

EU ETS cap 3rd+ periods (LRF 1.74%)

Sub-cap for free allocation (LRF 1.74%)

Sub-cap aviation

1st 2nd Period 3rd Period 4th+ Periods

Source: CEC 2010b, EU 2009a, calculations by Öko-Institut

Consequently the debate on EU ETS caps must focus on the short- and medium-term

aspects (cf. chapter 3 to 6) as well as the longer-term consistency (cf. chapter 7).


- 23 -

3 The recent problem: Allowance surplus from 2008 to

2011

3.1 Introduction, scope and structure of the analysis

The analysis presented in the following chapters focuses on the surplus of allowances

which occurred from 2008 to 2011. For this period a consistent set of historical data is

available for the EU ETS. The analysis does not reflect the respective data from the

first trading period of the EU ETS because banking was not allowed from the pilot peri-

od (2005-2007) to the second trading period (2008-2012) and is consequently not rele-

vant for the surplus analysis.

The specification of the surplus for the period from 2008 to 2011 is based on the follow-

ing analysis:

1. The trends of verified emissions in the EU ETS specify the demand for emis-

sions allowances by the regulated entities (cf. chapter 3.2).

2. The supply of emissions allowances or substitutes arises from different sources

which are documented separately:

a. A major share of emissions allowances were made available by free al-

location to the operators of the respective installations (cf. chapter 3.3).

b. Some allowances were supplied by auctions or government sales at

market prices (cf. chapter 3.4);

c. The operators were entitled to use a certain amount of lower-priced

emissions reduction credits from the Clean Development Mechanism

(CDM) and Joint Implementation (JI) as a substitute for EU emission al-

lowances (cf. chapter 3.5).

The comparison of demand and supply (cf. chapter 3.6) allows the surplus accumulat-

ed by the end of 2011 and its pattern to be specified.

3.2 Trend of verified emissions in the EU ETS for 2008 to 2011

Data on verified emissions is available from the Community Independent Transaction

Log (CITL) on an installation level. Data on an aggregated level is published by the

European Environment Agency (EEA) in its EU ETS Dataviewer (EEA 2012).

In its current scope the EU ETS covers the 27 EU Member States, Norway and Liech-

tenstein. Verified emissions of all installations covered by the EU ETS were 2,123 mil-

lion tons of carbon dioxide (t CO2) in the year 2008. Due to the economic crisis emis-

sions dropped to 1,888 million t CO2 in the year 2009 and recovered to a level of 1,939

million t CO2 in the year 2010 (EEA 2012). In 2011 emissions decreased again to a

level of 1,903 million t CO2.


- 24 -

3.3 Free allocation for 2008 to 2011

Data on free allocation is also available from the Community Independent Transaction

Log (CITL) on an installation level. Data on an aggregated level is published by the

European Environmental Agency (EEA) in its EU ETS Dataviewer (EEA 2012).

Free allocation as recorded in the EU ETS Dataviewer was 1,961 million t CO2 in the

year 2008, increasing to 1,976 million t CO2 in the year 2009, 1,998 million t CO2 in the

year 2010 and 2,001 million t CO2 in the year 2011.

3.4 Auctions and sales for 2008 to 2011

Data on auctioned or sold volumes of EUAs are not provided by the CITL or by another

comprehensive data compilation. However, Member States generally publish the

amount of allowances which were brought to the market by auctions or sales. In addi-

tion, the website of DG Clima also keeps track of the amount of EUAs auctioned by

Member States.

Based on the data compiled by EEA (2012) the amount of EUAs auctioned or sold in

2008 was 45 million EUAs, exclusively from Germany and the UK. In 2009 this volume

increased to nearly 80 million EUAs in 2009, 92 million EUAs in 2010 and 83 million

EUAs in 2011. However, in some Member States auctions or sales were planned but

the set-up of auctions and sales was and is still delayed.

3.5 Use of CDM and JI credits from 2008 to 2011

Data on the amount of CDM and JI credits surrendered by operators is recorded and

published by the Community Independent Transaction Log (CITL) on an installation

level. Data on an aggregated level is published by the European Environmental Agency

(EEA) in its EU ETS Dataviewer (EEA 2012). In the years 2008 to 2011 operators cov-

ered by the EU ETS surrendered a total of 456 million offset credits from the CDM

(Certified Emissions Reduction Units – CER) and a total of 99 million emission reduc-

tion units from JI (Emission Reduction Units – ERU) to the competent authorities. Total

use of flexible mechanisms equals to 556 million CERs and ERUs in the four years

from 2008 to 2011.

3.6 Demand and supply balance for 2008 to 2011

Table 4 compares the amount of EUAs, CERs and ERUs available in the years 2008 to

2011 with the verified emission data for this period. In 2009, 2010 and 2011 the verified

emissions were lower than the free allocation to operators. As EUAs were auctioned on

top and operators used CERs and ERUs to cover their emissions a significant surplus

of EUAs has been accumulated.


- 25 -

Table 4 Surplus of allowances in the EU ETS, 2008-2011

Total

2008 2009 2010 2011 2008-2011

1,961 1,976 1,998 2,001 7,938

45 79 92 83 300

83 81 137 255 556

2,090 2,137 2,227 2,340 8,793

2,123 1,882 1,939 1,903 7,846

-33 255 289 436 947

-33 222 510 947Cumulated surplus

2nd trading period

Free allocation

Auctions and sales

CDM & JI

Total available units

Verified emissions

Surplus

mln EUA, CER, ERU or t CO2

Source: Calculations by Öko-Institut

The cumulated surplus of EUAs at the end of 2011 was nearly 1,000 million units. The

major share of this surplus (556 million EUAs) can be attributed to the fact that opera-

tors were allowed to surrender CERs and ERUs despite the fact that verified emissions

were below the available amount of EUAs.

The rest of the surplus (about 400 million EUAs) stems from the reduced emissions in

the years 2009 to 2011. This can mainly be attributed to the economic crisis during this

period.


- 26 -

4 The future challenge: Projection for the EU ETS surplus

until 2020

4.1 Introduction, scope and structure of the analysis

In contrast to the period from 2008 to 2011 no historical data can be used to specify the

potential surplus of allowances for the period from 2012 onwards and a projection for

the supply and demand must be developed.

1. The key determinant on the demand side is the baseline projection for emis-

sions regulated by the EU ETS. With respect to the baseline, three aspects are

of special importance: firstly the underlying assumptions on economic growth as

a key driver for greenhouse gas emissions, secondly the penetration of renew-

able energies as well as energy savings as a result of complementary policies

to the EU ETS and thirdly the effects of the extended scope of the EU ETS from

2013 onwards (cf. chapter 4.2).

2. The supply side for allowances and offset credits is analysed in respect of the

different sources of supply:

a. The decreasing share of free EUA allocation to the operators of the

regulated installations (cf. chapter 4.3);

b. The increasing share of allowances supplied at market prices via auc-

tions (cf. chapter 4.4);

c. The qualitatively and quantitatively restricted supply of offset credits

from the CDM or JI at prices lower than for EUAs (cf. chapter 4.5);

d. The free allocation to eligible new entrants from the new entrant re-

serve (cf. chapter 4.6).

The compilation of all sources for demand and supply enables an integrated projection

for the balance of demand and supply from 2012 to 2020 (chapter 4.7).

4.2 Baseline emission trends for the EU ETS from 2012 to 2030

The emission reduction effort within the EU ETS results from the difference of the

emission levels in a baseline trend and the cap. The baseline scenario is the counter-

factual scenario of what would occur in a regulatory environment without a price on

greenhouse gas emissions. Key determinants for the baseline emission trend in the

sectors regulated by the EU ETS are:

the demographic and economic trends as essential driving forces;

the energy and investment costs as significant factors influencing energy supply

and demand patterns; and


- 27 -

the general regulatory framework and complementary instruments to the EU

ETS, especially separate support schemes for renewable energies and energy

efficiency.

The cap definition for the EU ETS from 2013 onwards was based on an integrated

analysis for the 2008 climate and energy package of the European Union (Capros et al.

2008) which reflected both the overarching greenhouse gas emission reduction targets

for the EU as well as the plans to increase the share of renewable energy sources in

the energy mix and particularly in the power sector.

Figure 3 Comparison of GDP projections for ETS-relevant modelling exercises for

the European Union, 2005-2030

80%

90%

100%

110%

120%

130%

140%

150%

160%

170%

180%

2000 2005 2010 2015 2020 2025 2030 2035

20

05

= 1

00

%

EU Energy & Climate Package analysis (2008)

EU Energy Roadmap 2050 analysis (2011)

1.8...2% GDP growth from 2014

1.5% GDP growth from 2014

Historical data

-14%

-13%

-19%

-17%

Source: Eurostat, European Commission, calculations by Öko-Institut

However, some of the assumptions for the integrated modelling exercise carried out in

2008 no longer reflect the real trends for some key determinants of the baseline sce-

nario.

First of all, the short-, medium- and long-term economic outlook for the EU-27 has

changed significantly since 2008. Figure 3 indicates a range of projections for the de-

velopment of the gross domestic product (GDP), the key indicator for economic activi-

ties in a country or region.

For the modelling exercises on the EU energy and climate package in 2008 the

assumption for GDP growth from 2005 to 2030 amounted to an increase of ap-

prox. 43 % by 2020 and 71 % by 2030;


- 28 -

For the numerical analysis on the EU Energy Roadmap 2050 in 2011 (CEC

2011d) the modelling assumption was a total GDP growth from 2005 to 2020 of

approx. 28 % by 2020 and 52 % by 2030;

With respect to the most recent developments and trends two additional vari-

ants were analysed, the return to an annual of growth of 1.8 to 2.0 % during the

next two decades and a rather slow economic growth of about 1.5 % annually,

which results in a total GDP growth of approx. 17 to 21 % by 2020 and 38 to

48 % by 2030.

As a result, the total economic activity represented by GDP will be 14 to 17 % lower by

2020 and 13 to 19 % lower by 2030 than assumed in the analysis for the 2008 EU en-

ergy and climate package and thus for the cap of the EU ETS. Such changes for one of

the major driving forces for the baseline emission trend must result in a major change

of the emission reduction effort built into the cap of the EU ETS.

Furthermore, the massive support of renewable energy sources (RES) in the frame-

work of the 2008 EU energy and climate package could have a major impact on the

respective emission reduction efforts to be delivered by the EU ETS. For renewable

energy the following dimensions must be considered:

In terms of the EU ETS the EU-wide target for the expansion of renewable en-

ergies will mainly have an effect on the power generation from renewable ener-

gy sources; the share of renewables in the heat and transport market is of much

less or of no significance for the installations regulated by the EU ETS.

When the modelling for the 2008 EU energy and climate package was conduct-

ed, the analysis was based on certain assumptions for the power generation

from renewable energy sources. Subsequently and within the framework of the

EU Directive on Renewable Energies (EU 2009c) the Member States developed

National Renewable Energy Action Plans (NREAP) which include sectoral tar-

gets and projections for the different sectors. The deployment trends and tar-

gets for the renewable energies are not necessarily consistent with the underly-

ing assumptions of the 2008 modelling exercises.

Last but not least, the historical data for the development of renewable energies

in the power sector must not necessarily fit into the projections in terms of levels

and structures of RES deployment.

In order to make the data comparable for the purpose of the analysis presented in this

paper, the power generation from different renewable energy sources was transformed

into avoided CO2 emissions based on the following assumptions6:

Power generation from solar energy was assumed to substitute natural gas-

fired power plants;

6 These assumptions are in line with our own modelling exercises as well as the respective

literature (ISI 2005+2009).


- 29 -

Power generation from hydro, biomass, geothermal heat and ocean energy was

assumed to substitute hard coal-fired power plants; and

Power generation from wind energy was assumed to substitute a mix of hard

coal-fired plants (75 %) and natural gas-fired power plants (25 %).

Figure 4 Comparison of CO2 emission abatement contributions from renewable

energy sources in the power sector for the EU, 2005-2020

0

200

400

600

800

1,000

1,200

1,400

2005 2010 2015 2020 Integratedpackage

Baseline Integratedpackage

Baseline

Historical data NREAP (2011) 2020 projection (2008) 2030 projection (2008)

mln

t C

O2

Geothermal

Solar & ocean

Wind

Biomass

Hydro

Source: Eurostat, European Commission, calculations by Öko-Institut

Figure 4 provides an overview of the RES deployment trends in the EU power sector

from the three data sources mentioned above:

The data indicate that the trend of historical data is all in all consistent with the

projections submitted by the Member States in the National Renewable Energy

Action Plans (NREAP) in 2011 (EEA 2011).

The 2008 modelling for the EU energy and climate package and its integrated

targets for greenhouse gas emission reduction, the revision of the EU ETS and

the deployment of renewable energy sources for 2020 indicate that the effects

of an increased support for renewable energy sources are significant in terms of

CO2 emission abatement.7

7 For the modelling of the “Integrated package” projection a broad range of policies and

measures was considered while the “Baseline” modelling describes a projection in absence of these new policies and measures at EU level. The “Integrated package” projection refers to the CSE scenario in the documentation of the modelling exercise (Capros et al. 2008) and the “Baseline” projection refers to the respective baseline case.


- 30 -

However, the result of this analysis shown in Figure 4 underlines that the projections

submitted by the EU Member States in their NREAPs represent in total a level of CO2

emission abatement which only differs slightly (approx. 40 Mt CO2 or 5 % in 2020) from

the assumptions for the 2008 modelling exercise conducted for the integrated energy

and climate package, which was also the basis for the cap setting within the EU ETS

from 2013 onwards. However, the data compilation also shows that the pattern of RES

deployment differs significantly (the NREAPs present a much more significant role of

wind and solar energy and a significantly lower share of biomass), but due to the differ-

ent substitution patterns this does not result in a major difference in emission abate-

ment effects by RES which would be relevant for the cap assessment.

Figure 5 Update of the baseline projection for the EU ETS (scope of the second

trading period), 2020

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Baseline CO2emissions 2020

CO2 abatementfrom RES 2020

CO2 abatementfrom RES 2020

Lower GDP growth2020

Difference to 2008baseline for 2020

EU Package analysis (2008) Baseline update (2012)

mln

t C

O2

Source: European Commission, calculations by Öko-Institut

Based on a decomposition analysis the 2008 baseline projection was updated to the

new assumptions on GDP growth (reflecting the 1.8 to 2.0 % growth pathway present-

ed in Figure 38) and the (slightly) changed projections for the deployment of renewable

energy sources. The potential effects of a transition of the recent indicative energy effi-

ciency target to a mandatory efficiency target, as recently negotiated in the framework

of the proposal for an energy efficiency directive, were not included in the updated

baseline for two reasons. Firstly, the overall effect of such a binding target on energy

efficiency cannot be quantified at the recent stage of negotiation at an appropriate level

8 This assumption is slightly below the historical trend in the last decade before the financial

and economic crisis (approx. 2.5 %).


- 31 -

of uncertainty. Secondly, and more importantly, it is rather impossible at the current

stage to translate the emerging additional energy efficiency efforts in additional green-

house gas emission abatement for the sources regulated by the EU ETS, especially

the electricity generation sector.

Therefore, the updated baseline assumes no further changes in energy and carbon

intensity (with the exception of the respective effects of renewable energies) and repre-

sents a difference to the originally used baseline of about 425 Mt CO2 for 2020 which

results essentially from the lower GDP growth assumptions and is significant with re-

spect to an assessment of the EU ETS cap.

Furthermore, the projection for the emissions from aviation was updated, considering

the different system boundaries of the aviation sector in energy balances and emission

inventories on the one hand and the scope of the EU ETS with respect to aviation. The

updated projection is based on the average emissions from 2004 to 2006 (220 Mt

CO2), which form the basis for the aviation-specific part of the cap in the EU ETS. The

projection for the emissions from aviation is based on this 2005 emission level and the

growth rates for the final energy use by aviation from the modelling exercise for the EU

Energy Roadmap 2050, which represents the most recent EU-wide trends for aviation

(CEC 2011d).

Figure 6 Comparison of historical CO2 emissions data and baseline projections

for the EU ETS (scope of the second period and aviation), 2005-2030

0

500

1,000

1,500

2,000

2,500

3,000

Baseline2008

Historicaldata

Historicaldata

Historicaldata

Baseline2008

Update2012

Baseline2008

Update2012

2005 2010 2011 2020 2030

mln

t C

O2

Aviation

Stationary ETS sectors (3rd period scope)

Source: European Commission, calculations by Öko-Institut

Figure 6 summarizes the historical data and the updated baseline projections for the

sectors regulated by the EU ETS for the scope of the second trading period as well as

the aviation sector which falls in the scope of the EU ETS since 2012. For the station-


- 32 -

ary part of the EU ETS the counterfactual (reflecting the updated GDP growth assump-

tions as well as the updated emission abatement from RES) is an emissions trend

which increases slightly over time but remains more or less at emission levels which

were observed during the last few years. The difference to the baseline trends used for

the definition of the cap from 2013 onwards amounts to 385 Mt CO2 in 2020 and 365

Mt CO2 in 2030 which equals a 16 % reduction. This significant reduction of the base-

line levels is partly compensated by an increased baseline assumption for the aviation

sector (+67 Mt CO2 in 2020 and +38 Mt CO2 in 2030). However, with respect to the fact

that the cap for aviation was derived separately and is based on data which have no

direct link to the 2008 modelling of the baseline, the offsetting effects of the increased

aviation baseline are not relevant for the assessment of the 2008 baseline assump-

tions.

Last but not least, emissions from new sectors will fall under the scope of the EU ETS

in 2013 (e.g. N2O from industrial gases, PFC from Aluminium and others). The starting

point for specifying the respective increase of the cap is 107 million EUA in 2013, which

reflects the fact that the UK, the Netherlands, Austria, Italy and Norway already opted

in their nitric acid and adipic acid production during the second trading period of the EU

ETS.

According to Article 9a (2) of the revised EU ETS Directive Member States had to notify

verified emissions of new installations entering the EU ETS from 2013 to determine the

increase of the cap. For non-CO2 gases Member States were allowed to “notify a lower

amount of emissions according to the reduction potential of those installations” (Article

9a (2)). Unfortunately there is no information available on the extent to which Member

States took the reduction potential into account when the cap increase for nitric acid

and adipic acid production was determined.

Recently implemented or announced JI projects for the abatement of N2O within the EU

have resulted in impressive emission reductions which are part of the baseline because

they were mainly triggered by non-ETS policies. Therefore, it can be expected that

emissions from nitric acid and adipic acid production will be drastically reduced in the

third trading period of the EU ETS. In 2008 N2O emissions from nitric acid and adipic

acid production was 33 million tons of carbon dioxide equivalent (t CO2e) in the EU-27

without installations opted in by the Netherlands and Austria (ETC/ACC 2010). Based

on data from ETC/ACC (2010) the emission reduction could be as high as 30 million t

CO2e in the years from 2013 onwards compared to emissions in the year 2008. If

Member States have taken this reduction potential into account, there will be no sur-

plus from installations entering the EU ETS from 2013 onwards. If Member States have

not taken this reduction potential into account, the annual surplus could be 30 million

EUA. It is assumed that half of the reduction potential was taken into account. Thus

emissions are estimated at a level of 91 million EUA for the years 2013 to 2020 (de-

ducting 15 million EUA from the level of 107 million EUA mentioned above).


- 33 -

Table 5 Updated baseline emission trends for the EU ETS sectors, 2005-2030

2005 2010 2011 2012 2013 2014 2015 2020 2025 2030

Stationary ETS II scope 2,230 1,939 1,903 1,892 1,886 1,898 1,912 1,954 1,954 1,954

Stationary ETS III scope - - - - 91 91 91 91 91 91

Aviation 221 - - 239 245 251 257 285 295 293

Total - - - - 2,222 2,240 2,260 2,330 2,340 2,338

mln t CO2e

Note: Due to the different scope of the EU ETS (stationary sources, aviation) no totals are given for the years before 2013. Source: Calculations by Öko-Institut

Table 5 summarizes the updated baseline emission trends for the different scopes of

the EU ETS. The total emissions in the baseline increase by 50 million t CO2 for sta-

tionary installations and by 54 million in the aviation sector by 2020 compared to the

current emission level (2011/2012). For 2030 the baseline emissions are almost con-

stant compared to the 2020 levels.

4.3 Free allocation from 2012 to 2020

As a starting point it is assumed that the free allocation for the year 2012 will be equal

to the free allocation in the year 2011. Thus free allocation would be 2,001 million t CO2

in the year 2012.

Table 6 Amount of free allocation, 2008-2020

Total

2008 2009 2010 2011 2012 2013 2014 2015 2020 2008-2020

Stationary ETS II scope 1,961 1,976 1,998 2,001 2,001 820 799 778 639 15,839

Stationary ETS III scope 77 77 77 72 607

Aviation 183 179 179 179 179 1,613

Power generators EU-12 221 190 158 0 885

Total 1,961 1,976 1,998 2,001 2,184 1,297 1,244 1,192 890 18,943

mln EUA

2nd trading period 3rd trading period


From 2013 onwards auctioning will be the rule for electricity generation. Free allocation

in the industrial sector and for heat generation will be based on benchmarks. Based on

Öko-Institut’s ARRA-Model9 the free allocation for installations that already participated

in the second trading period of the EU ETS will decrease from 820 million EUA in 2013

to 639 million EUA in 2020. According to Article 10c of the EU ETS Directive (EU

2009a) some (mainly eastern European) Member States can allocate free allowances

for electricity generators. Only the decisions for Cyprus, Estonia and Lithuania have

9 ARRA stands for Auctioning Revenues and Redistribution Analysis; the model provides pro-

jections for free allocation and auctioning revenues at the level of EU Member States.


- 34 -

been published (CEC 2012). Therefore, the free allocation to electricity generators in

the EU-12 was estimated (Table 6).10

Table 7 Amount of free allocation from the new entrant reserve, 2013-2020

Total

2013 2014 2015 2016 2017 2018 2019 2020 2013-2020

Stationary ETS II scope 13 25 38 51 64 76 89 102 457

Stationary ETS III scope 1 1 2 3 3 4 5 5 24

Total 13 27 40 54 67 80 94 107 482

mln EUA

3rd trading period


Additionally there will be free allocation to new entrants from industrial sectors from the

new entrant reserve. The total size of the new entrant reserve is 5 % of the cap for sta-

tionary installations. This equals 782 million EUA for the period from 2013 to 2020. Of

this total 300 million EUA will be auctioned to finance CCS and innovative renewable

projects. As a result 482 million EUA are available that can be allocated to new en-

trants for free (Table 7).

4.4 Auctions and sales from 2012 to 2020

In the year 2012 auctions and sales can be assessed based on the publication of auc-

tions on the DG Clima website or announcements by the member states. To calculate

the amount of auctions from 2013 onwards the free allocation and the new entrant re-

serve is deducted from the cap. In the aviation sector 15 % of the cap will be auctioned,

leading to annual auctions of 32 million units.

Of the new entrant reserve – equaling 5 % of the cap – 300 million EUAs will be auc-

tioned or sold to finance CCS and innovative renewable energy projects. A first tranche

of 200 million EUAs will already be auctioned or sold by October 2012 (CEC/EIB 2010).

However, as these allowances can only be used from 2013 onwards they are attributed

to the auctions and sales in 2013 (Table 8).

10

It is assumed that in 2013 allowances equal to 70 % of historic emissions in the power sector are allocated for free. This percentage decreases linearly to 10 % in 2019, leading to no free allocation to the power sector in 2020. In its guidance document (CEC 2011f) the European Commission has allowed slight deviations from the rule that free allocation has to decrease linearly. However, the assessment of decision for Cyprus, Estonia and Lithuania shows that for these countries deviations from the rule that free allocation has to decrease linearly are rather low. It will be necessary to update the estimated free allocation for power generation once all decisions are published.


- 35 -

Table 8 Amount of allowance auctions and sales, 2008-2020

Total

2008 2009 2010 2011 2012 2013 2014 2015 2020 2008-2020

Stationary ETS II scope 45 79 92 83 72 1,064 1,050 1,036 1,003 8,571

Stationary ETS III scope 24 22 20 16 147

Aviation 32 32 32 32 32 285

NER phase III auctions 300

Power generators EU-12 -221 -190 -158 0 -885

Total 45 79 92 83 105 898 914 929 1,050 8,118

2nd trading period 3rd trading period

mln EUA


Auctioning quantities are calculated as the difference between the cap and the free

allocation. As free allocation to electricity generation in the Central and Eastern Mem-

ber States decreases over time the total amount of EUAs available for auctioning in-

creases from 898 million EUAs in 2013 to 1,050 million EUAs in 2020.

4.5 Use of CDM and JI credits from 2012 to 2020

The total use of emission reduction credits from CDM or JI projects in the EU ETS for

the period from 2008 to 2020 is restricted in quantitative and qualitative terms. Article

11a paragraph 8 of the revised EU ETS Directive states that the overall use of these

credits shall not exceed 50 % of the reduction effort in the EU ETS compared to the

emissions in the year 2005 for the EU ETS scope II or compared to the emission levels

at the date of inclusion for further scope extensions of the EU ETS. This top-down

quantity restriction indicates an upper bound. The exact quantity of CDM or JI credits

(CERs or ERUs) that can be used by operators is regulated bottom-up on an installa-

tion level (Article 11a paragraph 8).

This provision sets the following rules for allocating the entitlements for the use of

CERs and ERUs to the operators:

All existing operators are allowed to use credits in the period 2008 to 2020 up to

the amount permitted to them in the second trading period according to the re-

spective provisions in the National Allocation Plans. Operators can also use the

left-overs from their entitlements for the second trading period in the third trad-

ing period. The National Allocation Plans for the second trading period define

the entitlements for the use of CERs and ERUs in general as a percentage of

the free allocation for each operator in the period 2008 to 2012. The exact per-

centage for each country is published in the NAP table decisions and varies

from 0 % in Estonia to 22 % in Germany. Based on the data on free allocation

from the CITL and the estimated allocation to new entrants (assuming that all

allowances from the new entrant reserve will be allocated for free) in the second

trading period the total allowance for the use of credits can be derived.

In some countries operators received comparatively low entitlements for the use

of CERs and ERUs for the second trading period (e.g. operators in the UK).


- 36 -

Operators from these countries will be allowed to use additional credits from

2013 onwards. These additional entitlements are limited to an amount that en-

sures that the total entitlement does not exceed a percentage of 11 % of the

free allocation of the respective installations in the period from 2008 to 2012.

Table 9 Entitlements for the use of CDM and JI credits for operating installations

from the EU ETS scope II, 2008-2020

CER/ERU

use

Additional

CER/ERU

use

Total

CER/ERU

use

Total free

allocation

Total

CER/ERU

use

Use of

CER/ERU

Available

CER/ERU

use

2008-2012 2013-2020 2008-2020 2008-2012 2008-2020 2008-2011 2012-2020

mln EUA

Austria 10% 1% 11% 160 18 5 13

Belgium 8% 3% 11% 281 31 9 22

Bulgaria 13% 0% 13% 190 24 14 10

Cyprus 10% 1% 11% 27 3 1 2

Czech Republic 10% 1% 11% 431 47 16 31

Denmark 17% 0% 17% 120 20 5 16

Estonia 0% 11% 11% 67 7 0 7

Finland 10% 1% 11% 188 21 8 12

France 14% 0% 14% 657 89 43 46

Germany 22% 0% 22% 1,983 436 162 274

Greece 9% 2% 11% 324 36 14 21

Hungary 10% 1% 11% 121 13 7 7

Ireland 10% 1% 11% 104 11 4 7

Italy 15% 0% 15% 1,011 152 49 103

Latvia 10% 1% 11% 21 2 1 1

Liechtenstein 11% 0% 11% 0 0 0 0

Lithuania 20% 0% 20% 39 8 4 3

Luxembourg 10% 1% 11% 12 1 1 1

Malta 10% 1% 11% 11 1 0 1

Netherlands 10% 1% 11% 423 47 8 38

Norway 11% 0% 11% 40 4 6 -2

Poland 10% 1% 11% 1,023 113 56 57

Portugal 10% 1% 11% 160 18 8 10

Romania 10% 1% 11% 370 41 17 24

Slovakia 7% 4% 11% 162 18 9 9

Slovenia 16% 0% 16% 41 6 3 4

Spain 20% 0% 20% 757 151 69 82

Sweden 10% 1% 11% 111 12 3 9

United Kingdom 8% 3% 11% 1,099 121 34 87

EU-27 1,447 549 898

All countries 15% 9,934 1,451 555 896

% of free allocation in Phase II mln CER or ERU

Source: EEA (2012), NAP table decisions, calculations by Öko-Institut

From 2013 to 2020 new entrants that start operation from 2013 onwards are al-

lowed to use credits for up to 4.5 % of their annual verified emissions. New en-

trants from the period from 2008 to 2012 that received a free allocation or an


- 37 -

entitlement to use credits in the period from 2008 to 2012 can use this entitle-

ment but do not receive any additional entitlements. From 2013 to 2020 opera-

tors of installations from new sectors that enter the scope from 2013 onwards

are allowed to use credits for up to 4.5 % of their annual verified emissions. The

percentage used for new entrants that start operation from 2013 onwards and

for new sectors can also be increased in the comitology procedure.

In the year 2012 aviation operators are allowed to use CERs and ERUs for up

to 15 % of their annual verified emissions. From 2013 to 2020 aviation opera-

tors are allowed to use credits up to 1.5 % of their annual verified emissions.

This percentage can also be increased in the comitology procedure.

It is important to note that the legally binding quantity is the bottom-up quantity. In theo-

ry the comitology procedure could be used to increase the entitlements for the use of

credits from CDM and JI. For the purpose of this study it is assumed that this will not

occur.

The use of entitlements for the use of CDM/JI credits can easily be calculated for the

different groups of installations (Table 10).

For all existing operators the free allocation is available from the CITL. In order

to calculate the CER and ERU entitlements the allocation for each year is multi-

plied with the country-specific percentage for the use of credits. This gives the

total amount of credits that has been allowed to operators already in the second

trading period from 2008 to 2012;

The expected use of credits by new entrants that start operation in the period

from 2008 to 2012 is expected to be approx. 27 million CER and ERU for 2008

to 2020. This quantity is calculated by multiplying the difference between the

cap on the one hand and the free allocation and auctioned allowances on the

other hand in the period from 2008 to 2012 (this should equal the size of the

new entrants reserve) with the average specific percentage for the CER and

ERU entitlements (14 % of free allocation);

The baseline emissions of new entrants starting operation from 2013 onwards

are difficult to estimate. It is assumed that the total emissions in the period from

2013 to 2020 of new entrants starting operation from 2013 onwards will be

about 962 Mt CO2e11 Since new entrants are allowed to use credits equal to

4.5 % of their verified emissions the use of credits by this group will be 43 mil-

lion credits at maximum.

11

The new entrant reserve is defined as 5% of the cap (781 million EUA for the scope of the second and third trading period). Of this total, 300 million EUAs will be auctioned. The remaining quantity (481 million EUA) is doubled in order to correct for the fact that electricity generators do not receive a free allocation from 2013 onwards but can still use CERs and ERUs.


- 38 -

In order to make a conservative estimate for the use of credits by new sectors it

is assumed that the emissions of the new sectors entering the scope of the EU-

ETS will be reduced to a level of 91 Mt CO2e up to 2020. Since new sectors are

allowed to use credits equal to 4.5 % of their verified emissions the use of cred-

its by this group could be about 4 million CERs and ERUs annually.

In 2012 aviation operators are allowed to use credits for up to 15 % of their an-

nual verified emissions. From 2013 to 2020 aviation operators are allowed to

use credits up to 1.5 % of their annual verified emissions. Based on the as-

sumption that the emissions of the aviation sector will increase by 29 % by 2020

compared to 2005 (CEC 2011d) the allowed use of CDM/JI credits amounts to

68 million credits in the period from 2008 to 2020.

Table 10 Total entitlements for the use of CDM and JI credits, 2008-2020

2008-2020

mln CER or ERU

Stationary ETS II scope 1,522

of this existing installations 1,451

of this new entrants in phase II 27

of this new entrants in phase III 43

Stationary ETS III scope 33

Aviation 68

Total 1,622 Source: Calculations by Öko-Institut

The entitlements for the use of flexible mechanisms total more than 1,600 million CERs

and ERUs from 2008 to 2020 (Table 10). As 555 million CERs and ERUs have already

been surrendered by operators under the EU ETS in the four years from 2008 to 2011,

a further 1,065 million CERs and ERUs are available for surrender from 2012 to 2020.

4.6 New entrant reserve for the second trading period

Table 11 compares the cap in the second trading period with the amount of EUAs allo-

cated for free and auctioned or sold. A key finding from this comparison is that the total

cap for the second trading period from 2008 to 2012 is 185 million EUAs higher than

the amount of EUAs allocated for free and auctioned.

Table 11 Comparison of cap, free allocation, auctions and sales, 2008-2012

2008 2009 2010 2011 2012 total

Cap 2,099 2,099 2,099 2,099 2,099 10,496

Free allocation -1,961 -1,976 -1,998 -2,001 -2,001 -9,939

Auctions and Sales -45 -79 -92 -83 -72 -372

Difference (= reserves) 93 43 9 15 25 185

2nd trading period

mln EUA

Source: CITL, EEA (2012), calculations by Öko-Institut


- 39 -

The reasons for this difference are not fully clear. One important explanation is that

there are still allowances in the new entrant reserves which were not yet allocated to

operators. However, there are very likely other factors that explain this difference (for

example that not all new entrant allocations are recorded in the CITL). In order to cal-

culate a full demand and supply balance, these 185 million EUAs are attributed to the

year 2012.

4.7 Total supply and demand balance for 2012 to 2020

Table 12 provides an overview of the available amount of emissions allowances (EUA)

as well as the entitlements for the use of credits from CDM or JI projects (CERs or

ERUs) and the projected baseline emissions for 2012 to 2020.

From 2012 to 2020 a total of approx. 20,860 emissions allowances or CDM or JI credits

will be available for the operators regulated by the EU ETS. Although free allocation is

significantly reduced from 2013 onwards, the total free allocation (free allocation to

existing installations as well as free allocation from the new entrant reserves) exceeds

half of all available units for 2012 to 2020 (55 % for 2012 to 2020 and 51 % for the third

trading period). The allocation at market prices via auctions and sales represents about

40 % of the total supply of allowances (39 % for 2012 to 2020 and 44 % for the third

period).

A total amount of 1,066 million CER and ERU, i.e. low-cost emissions credits from

CDM and JI will be available for surrender in the EU ETS from 2012 to 2020. This

amount exceeds significantly the projected oversupply by 2020. Without further enti-

tlements for the use of CERs and ERUs there would have been a scarcity (and a high-

er price) in the EU ETS from 2014 onwards.

Table 12 Demand and supply balance, 2012-2020

2012 2013 2014 2015 2016 2017 2018 2019 2020 Total

2012-20

2,184 1,297 1,244 1,192 1,140 1,085 1,019 954 890 11,006

105 898 914 929 945 963 993 1,022 1,050 7,818

0 300 0 0 0 0 0 0 0 300

278 98 98 98 99 99 99 99 99 1,066

0 13 27 40 54 67 80 94 107 482

185 0 0 0 0 0 0 0 0 185

2,752 2,606 2,283 2,260 2,237 2,214 2,191 2,168 2,145 20,857

2,131 2,222 2,240 2,260 2,278 2,293 2,307 2,322 2,330 20,382

620 384 43 0 -41 -78 -116 -154 -185 475

620 1,005 1,048 1,049 1,007 929 813 659 475

from 2008 1,567 1,952 1,995 1,995 1,954 1,876 1,760 1,606 1,422

mln EUA, CER and ERU

Free allocation NER III

Left-over NER II

Cumulated surplus

Baseline emissions

Free allocation

Auctions and sales

NER auctions phase III

CDM and JI credits

Surplus

Total available units



- 40 -

The baseline emissions reach the level of allowance and credit supply in 2015 and ex-

ceed this level from 2016 onwards. In other words: without the availability of the surplus

from the period before 2015 a scarcity would occur for the years after 2015.

The surplus created from 2012 to 2020 peaks in 2015 and reaches a level of approx.

1,050 million EUAs. Due to the decreasing cap the oversupply is reduced over time

and reaches a level of less than 475 million EUAs by 2020. However, the surplus cre-

ated from 2008 to 2011 must also be considered, which adds up to a total surplus of

about 1,425 million units in 2020.


- 41 -

5 Interim summary: Demand and supply balance 2008 to

2020

The balance for supply and demand from 2008 to 2020 is shown in Table 1. It clearly

shows that even the supply from free allocations in the second trading will exceed the

total emissions and all other supplies will further increase the surplus of this period,

which amounts to 16 % of the total demand from 2008 to 2012. For the third trading

period the total fresh supply of allowances and offset credits will be only 0.8% less than

the baseline emissions from 2013 to 2020. Due to the significantly increased share of

auctions in the total supply of allowances in third trading period, 44 % of all available

units will be available at the full prices only. However, for the whole period from 2008 to

2020 the supply still exceeds demand by 5 %. Three quarters of the demand for allow-

ances will be available free of charge or at low prices (free allocation and CDM/JI cred-

its, respectively).

Table 13 Demand and supply balance for the second and third trading period,

2008-2020

3rd period

Historical data

2008-2011 2012 2013-2020

% of demand

Free allocationa 7,938 2,184 9,304 19,425 68.8%

Auctions and salesb 300 105 8,013 8,418 29.8%

CDM and JI credits 556 278 789 1,622 5.7%

Left-over NER II - 185 - 185 0.7%

Total available units 8,793 2,752 18,106 29,650 105.0%

Emissionsc 7,846 2,131 18,251 28,229 100.0%

Surplus 947 620 -146 1,422 5.0%

Cumulated surplus 947 1,567 1,422

Notes: a Including free allocation from NER in the 3rd period. - b Including auctions from NER in the 3rd period (NER

300 autions). - c Verified emissions for 2008-2011, baseline emissions from 2012-2020.

2nd period

mln EUA, CER, ERU or t CO2e

Projection

Total

2008-2020


Figure 7 summarizes the different factors contributing to the surplus of allowances and

emissions reduction credits in the EU ETS. The cumulated surplus at the end of 2011

amounts to 1,000 million EUAs. The major share of the surplus accrued by 2011 (555

million EUA) is a result of the use of CDM and JI credits. The effects of the economic

crisis in the period from 2008 to 2011 (the number of available allowances exceeded

significantly the verified emissions) contributed a share of approx. 400 million EUAs to

the surplus.

According to the recent legislation the surplus will continue to increase by 2015 and will

still be significant in 2020.

The major reason for the increase of the surplus is that 1,000 million additional

CDM and JI credits can be surrendered by operators from 2012 to 2020;


- 42 -

This additional inflow of credits is only partly complemented by an additional

scarcity from ETS-regulated entities. It is worth mentioning that the major scar-

city from 2012 onwards will be created by the growing emissions from aviation

and only a comparatively low share results from the fact that the EUA supply is

lower than the baseline emissions from stationary sources under the scope of

the EU ETS.

Figure 7 Evolution of the surplus in the EU ETS, 2008-2020

0

500

1,000

1,500

2,000

2,500

Hisorical use ofCDM & JI credits

Crisis Future use ofCDM & JI credits

Demandaviation

Demandstationary sectors

Totalsurplus

2008 to 2011 2012 to 2020

mln

EU

A,

CE

R o

r E

RU


Overall the surplus in the EU ETS will be 1,420 million EUAs in 2020. The uncertainties

about the size of the surplus from 2008 to 2011 are obviously rather low. The effects of

the economic crisis and the total use of CDM and JI credits can be quantified well. For

the period beyond 2011 the uncertainties are significantly higher, namely on the de-

mand side of the balance:

The aviation sector contributes to a reduction of the surplus as cumulative

emissions are estimated to be approx. 450 million t CO2 higher than the number

of allowances provided by the sub-cap for the aviation sector from 2012 to

2020. If the aviation sector does not deliver the projected demand because sig-

nificant carriers pull out of the EU ETS (as a result of a political deal or because

other states take comparable action which would make the respective carriers

no longer subject to regulation by the EU ETS), the surplus of the EU ETS

would exceed the level of 1,400 million allowances significantly.

As emissions from stationary sources are projected to increase the available

number of allowances will be about 129 million t CO2 lower than baseline emis-


- 43 -

sions. If the economic recovery in the EU lasts longer than projected for the up-

dated baseline, this would also increase or prolong the surplus.

It is important to note that the majority of the projected surplus in the EU ETS results

from the additional inflow of emission reduction credits from CDM and JI projects. For

many of these projects the additionality of emission reductions has been questioned.

The major share of CDM credits surrendered under the EU ETS since 2008 was creat-

ed by projects which are now excluded from use under the EU ETS because of major

integrity concerns (Öko-Institut 2010, CEC 2011c). Although some more qualitative

restrictions apply for the use of CDM credits from 2013 onwards (EU 2009a), this chal-

lenge will remain a significant one and should be reflected in the debate on the future

use of emission reduction credits in the EU ETS.


- 44 -

6 Analysis of current proposals for intervention

6.1 Introduction, overview and structure of the analysis

If countermeasures are to be taken to deal with the existing or the emerging surplus of

allowances within the EU ETS, these interventions could address different issues:

The baseline emissions could be adjusted. With regard to the fundamental driv-

ers of the baseline emission trends (GDP etc.) this is obviously not a real option

but could be an option with a view to the complementary policies and measures

which are part of the baseline. If the complementary support for renewable en-

ergies or energy efficiency (or for other low-carbon options) is limited or re-

moved the efforts within the EU ETS would increase and the surplus would dis-

appear more quickly. However, given the existing political and legal framework

which explicitly addresses complementary measures (for strong and good rea-

sons) this is neither an appropriate nor a realistic way to take action on the EU

ETS surplus.

The cap could be tightened. If the number of available allowances is significant-

ly reduced (over time), this could accelerate the reduction of the surplus. Within

the architecture of the EU ETS from 2013 onwards the mechanism for tighten-

ing the cap is an increase of the linear reduction factor. Provisions for an ad-

justment of the linear reduction factor for various reasons exist in the recent EU

ETS legislation and could be applied without major problems if the political will

exists.

The restrictions on the inflow of external units which are fungible to EU ETS al-

lowances could be tightened, which means that the entitlements for using emis-

sion reduction credits would be reduced. Against the background of the very

disparate distribution of entitlements for using these credits in the second trad-

ing period a limitation of these entitlements for the period from 2013 to 2020

would lead to major distributional effects between operators in different Member

States and is probably one of the options which is difficult to implement.

As a temporary measure a share of the allowances could be held back (set

aside) and brought back to the market later or retired in the context of, for ex-

ample, a tightened cap for the EU ETS.

Two of these four general options are prominently subject to recent debates on sur-

plus-related adjustments of the EU ETS:

The European Parliament’s Committee on the Environment, Public Health and

Food Safety (ENVI) has tabled the concept of a set aside in its opinion on the

draft directive on energy efficiency (EP 2012). According to this proposal 1,400

EUAs would not be auctioned to the market and held back for future use or re-

tirement. Technically this proposal would be implemented by an adjustment of

the auctioning calendar laid down the auctioning regulation on the EU ETS.


- 45 -

In the same document ENVI proposed an adjustment of the linear reduction fac-

tor from 1.74 % to 2.25 annually. An adjustment of the linear reduction factor

would require a respective revision of the EU ETS Directive.

Both proposals have received support as well as resistance from both policy makers

and stakeholders. Therefore the analysis presented in this paper is focused on these

two options, their combination and different implementation approaches. It is structured

as follows:

Both proposals need specification to enable a more in-depth analysis. In chap-

ter 6.2 different implementation options and their combination are specified for

the following analysis.

In chapter 6.3 the effects of these options and their combinations on the EU

ETS surplus are analysed, based on the data and data structures presented in

the previous chapters.

The potential effects of the different options and their combinations on the EUA

prices are analysed in chapter 6.4, based on a simple methodological approach

presented in section 6.4.1. The results of this analysis are documented in sec-

tion 6.4.2.

The specification variants for the two general options mentioned above or their para-

metrization as well as the potential combinations are manifold. For the sake of pragma-

tism and illustration the analysis refers to the proposals specified by the European Par-

liament.

6.2 Specification of the options for the analysis

The analysis of the set aside requires three specifications: the number of allowances

held back, the respective change in the auctioning calendar and the plan for bringing

the allowances back to the market or to retire them.

The analysis of the set aside option and its combination with other options is based on

the following assumptions:

1. The set aside is defined as a total of 1,400 million EUAs;

2. It is built up from four equal tranches in four years from 2013 to 2016;

3. For the key question on the treatment of the set aside three approaches are de-

fined:

a. The set aside is brought back to the market during the third trading peri-

od, e.g. in four equal tranches from 2017 to 2020;

b. The set aside is reintroduced to the market with a ten year delay, in

equal tranches from 2023 to 2026;

c. The set aside is retired and is not brought back to the market.


- 46 -

The analysis of the adjustment for the linear reduction factor and its combination to

other options is based on the following assumptions:

Based on the proposal from the European Parliament the linear reduction factor

is increased from 1.74 % to 2.25 %. As a result the cap will be decreased an-

nually by 50 million EUA instead of 38 million EUA from 2014 onwards.

The increased linear reduction factor is applied for the years from 2014 onwards

as was proposed by the European Parliament with respect to the necessary

legislative process12. Compared to 2005 this equals an emission reduction of

25 % for the EU ETS-regulated stationary installations by 2020 and in the ab-

sence of any further changes of the cap a reduction of 89 % by 2050.

The increased linear reduction factor is applied to the stationary ETS-regulated

installations; for a variant it is assumed that the sub-cap for aviation is also ad-

justed annually with the linear reduction factor.

The additional reduction efforts triggered by a set aside and an increase of the linear

reduction factor are shown in Table 14. This compilation indicates some key aspects:

A set aside of 1,400 million EUA has an immediate effect on the reduction effort

and could reduce the surplus within a rather short time frame, especially if com-

pared to the effects of an increased linear reduction factor.

However, the schedule for the return of the set aside is of key importance. A re-

turn of the set aside within the third trading period would have no significant ef-

fect on the surplus.

The adjustment of the linear reduction factor delivers major effects over a longer

period of time. An increase from 1.74 % to 2.25 % leads to an additional cumu-

lated emission reduction of 315 million t CO2e from 2013 to 2020 and approx.

1,720 million t CO2e from 2013 to 2030.

In the long term the application of a more ambitious linear reduction factor to the

ETS-regulated aviation sectors can significantly increase the effort built into the

EU ETS. Applying the adjusted linear reduction factor of 2.25 % also for the

aviation sector increases the cumulated reduction effort by 139 million t CO2e

for 2013 to 2020 and approx. 762 million t CO2e for 2013 to 2030.

As an interim conclusion it can be stated that both interventions can be effective on a

significant scale (approx. 1.4 to 1.7 billion EUAs) for the next two decades on the one

hand. But on the other hand the time horizon for the respective effects is significantly

different. A set aside can deliver an increased effort within the EU ETS at a scale of 1.4

billion EUAs in a time frame of a few years whereas the increase of the linear reduction

12

It makes a significant difference if the adjusted linear factor reduction factor is applied from 2010 onwards or later. The reduction effort until 2020 is 315 million EUA with a linear factor starting in 2014 and 584 million EUAs with a linear factor starting in 2010; the difference be-tween these two options is 269 million EUAs from 2013 to 2020.


- 47 -

factor to tighten the cap is effective on this scale in a time frame of about 15 years.

However, an increased linear reduction factor would lead to much greater reduction

efforts for a period of two decades or more.

Table 14 Additional reduction efforts resulting from different options to reduce the

surplus in the EU ETS, 2013-2030

Annual 2013 2014 2015 2016 2017 2018 2019 2020

delayed 4 years 350 350 350 350 -350 -350 -350 -350

delayed 10 years 350 350 350 350

retired 350 350 350 350

EU ETS scope II 0 11 21 32 43 53 64 75

EU ETS scope III 0 1 1 2 2 3 3 4

Aviation 0 5 10 15 20 25 30 35

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

delayed 4 years

delayed 10 years -350 -350 -350 -350

retired

EU ETS scope II 85 96 107 117 128 139 149 160 171 181

EU ETS scope III 5 5 6 6 7 7 8 9 9 10

Aviation 40 45 50 55 60 65 70 75 80 85

Cumulative 2013 2014 2015 2016 2017 2018 2019 2020

delayed 4 years 350 700 1,050 1,400 1,050 700 350 0

delayed 10 years 350 700 1,050 1,400 1,400 1,400 1,400 1,400

retired 350 700 1,050 1,400 1,400 1,400 1,400 1,400

EU ETS scope II 0 11 32 64 107 160 224 299

EU ETS scope III 0 1 2 3 6 9 12 16

Aviation 0 5 15 30 50 75 105 139

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

delayed 4 years 0 0 0 0 0 0 0 0 0 0

delayed 10 years 1,400 1,400 1,050 700 350 0 0 0 0 0

retired 1,400 1,400 1,400 1,400 1,400 1,400 1,400 1,400 1,400 1,400

EU ETS scope II 384 480 587 704 832 971 1,120 1,280 1,451 1,632

EU ETS scope III 21 26 31 38 44 52 60 68 78 87

Aviation 179 224 274 329 389 453 523 598 678 762

Set-

aside

Increase

LRF to

2.25%

mln EUA

Set-

aside

Increase

LRF to

2.25%

Set-

aside

Increase

LRF to

2.25%

Set-

aside

Increase

LRF to

2.25%

mln EUA

mln EUA

mln EUA


With respect to the different time horizons and the scale of the existing and projected

surplus a series of combinations were analysed:

1. The three variants for a set aside of 1,400 million EUAs (returning 2017/2020,

returning 2023/2026, retired) for a cap based on the recent linear reduction fac-

tor of 1.74 % for stationary sources regulated by the EU ETS;

2. The three variants for a set aside of 1,400 million EUAs (returning 2017/2020,

returning 2023/2026, retired) for a cap based on an adjusted linear reduction

factor of 2.25 % as the base case and an application of this linear reduction

factor for the aviation sector from 2014 onwards.


- 48 -

All analysis reflects the third trading period of the EU ETS (2013-2020) as well as the

subsequent decade.

6.3 Reduction of the surplus in the EU ETS

The starting point for the analysis of interventions to reduce the surplus of allowances

in the EU ETS is the surplus of approx. 2,000 million EUAs in 2013. Without any inter-

vention (Base case) the EU ETS will be characterized by a surplus until 2024 (Figure

8). In other words: no scarcity will occur in the scheme before 2024. Even in 2020 the

surplus will amount to approx. 1,400 million EUAs.

Figure 8 Comparison of the effects of different options to reintroduce the set

aside on the surplus in the EU ETS at a cap level based on the linear

reduction factor of 1.74 %, 2013 to 2030

-2,000

-1,500

-1,000

-500

0

500

1,000

1,500

2,000

2,500

2014 2016 2018 2020 2022 2024 2026 2028 2030

mln

EU

A

Base case(no intervention)

Linear reduction factor 1.74%,set-aside retired

Linear reduction factor 1.74%,set-aside reintroduced 2017/2020



Figure 8 provides an overview of the effects of those intervention options which do not

include any adjustment of the cap, i.e. the linear reduction factor:

The set aside reduces the surplus in the scheme to 500 million EUAs in 2016.

If the set aside is brought back to the market before 2020, the turning point to-

wards scarcity in market is not reached and the surplus trajectory remains the

same as in the base case. There will still be a surplus in 2024 for this approach.

If the auctioning of the set aside is delayed for 10 years, the surplus will be fully

removed by 2020. A reintroduction of the set aside from 2023 onwards will not

lead to a surplus; the scarcity of allowances in the scheme would be main-

tained. The emission reduction effort in the EU ETS will slightly decrease by


- 49 -

2026 when the trajectory of cumulated demand is identical to the base case

again.

If the set aside were finally retired in 2023 a more ambitious emission reduction

trajectory would apply for the subsequent years.

Figure 9 Comparison of the effects of options to implement an increased linear

reduction factor on the surplus in the EU ETS, 2013 to 2030

-2,000

-1,500

-1,000

-500

0

500

1,000

1,500

2,000

2,500

2014 2016 2018 2020 2022 2024 2026 2028 2030

mln

EU

A

Base case(no intervention)

Linear reduction factor 2.25%,no set-aside



Linear reduction factor 2.25%(incl. aviation), set-asidereintroduced 2023/2026


Figure 9 illustrates the potential for reducing the surplus by an increase of the linear

reduction factor to 2.25 % from 2014 onwards and the combination of this intervention

with a set aside.

An isolated increase in the linear factor to 2.25 % delivers a long-term effect but

the point in time when the surplus turns into scarcity of allowances is only shift-

ed by about one year. In this case the surplus would be maintained by 2023.

If the increase of the linear reduction factor is combined with a set aside of

1,400 million EUAs from 2013 which enters the market ten years later, the sur-

plus is completely reduced by 2019, i.e. one year earlier than for the same set

aside approach combined with the linear reduction factor of 1.74 %. This differ-

ence seems to be small but the further trajectory of the scarcity of allowances in

the scheme indicates a significantly higher effort for the subsequent years. The

same effect occurs at a slightly higher level of ambition if the set aside is retired.

If the latter option is combined with a steady reduction of the cap for the aviation

sector by applying the linear reduction factor of 2.25 % to this cap as for the sta-

tionary sources, the scarcity is slightly increased again.


- 50 -

As a result, an effective and sustainable intervention in the EU ETS to reduce the sur-

plus should have three elements. Firstly, a set aside should be implemented as early

as possible. Secondly, the respective amount of allowances should not re-enter the

market for the duration of at least a decade. If the set aside is reintroduced to the mar-

ket in the third trading period this will have a lower effect. Thirdly, the set aside should

be combined with a tightened cap of the EU ETS by a significantly increased linear

reduction factor.

6.4 Potential range of price effects

6.4.1 Methodological approach

The effects of the different options to manage the surplus of emission allowances on

the allowances prices is assessed with a simple model derived from the analysis of

recent market trends.

Figure 10 Price trends for European Union Allowances (EUA) and EUA-CER

spreads, 2003-2012

0

5

10

15

20

25

30

35

40

45

50

01.2003 01.2005 01.2007 01.2009 01.2011 01.2013

€/

EU

A

Spot

Early Futures

EUA 2007

EUA 2012

EUA 2020

EUA-CERspread 2012

EUA-CERspread 2020

Release of 2005 emissions

data, long market,

no banking to 2nd period

Early hedging and speculation, early price discovery

Financial & economic

crisis, weak commodity

markets

EU climate & energy

package 2020,bullish

commoditymarkets

EU directiveon Energy Efficiency, ongoing

economic & debt crisis

Sources: Evomarkets, European Energy Exchange (EEX), European Climate Exchange

(ECX), calculations by Öko-Institut

The allowance price in the EU ETS has passed through different phases since the

startup of the scheme in 2005 (Figure 10):

The first market data on EUA trades have been available since late 2003 when

obviously the first hedging trades took place. After a lengthy process of price

discovery, to some extent determined by the stepwise and partially late notifica-

tion and approval process for the National Allocation Plans (NAP) of the Mem-


- 51 -

ber States, the EUA price reached levels of € 20 to 25 in 2005 and from € 25 to

30 in the first months of 2006.

After the first information on the level of verified emissions for the EU ETS-

regulated installations were made available in April 2006 it became clear that

the scheme would face a massive surplus of allowances and no scarcity of

emission allowances would exist for the pilot phase of the EU ETS. Given the

fact that banking was not allowed between the first and the second trading peri-

od, the price collapsed and decreased to levels of almost zero up to the end of

2007.

The start of the second trading period was characterized by significantly tight-

ened caps and by a bullish market for many commodities, specifically sharply

increasing prices for key fundamentals for the allowance price (petroleum prod-

ucts and natural gas) as well as a growing interest in speculation with emission

allowances from the EU ETS. EUAs were traded for € 25 to 30 for most of the

time but peaked at € 35 (for 2012 future contracts) in July 2008.

After the crash of the financial and commodity markets in the second half of

2008 and the following financial and economic crisis, the EUA price dropped to

€ 10 and recovered to levels of around € 15 by mid-2010.

In summer 2010 it became clear that the economic crisis in Europe would last

much longer than expected and that the cumulated surplus of emission allow-

ances would not disappear for a longer term. At the same time a proposal for an

ambitious energy efficiency directive was tabled which could result in additional

emission reductions in the EU ETS sectors. The EUA price dropped to levels of

around € 7.

With a view to the large surplus the question arises of why the EUA prices did not drop

to zero as observed between the first and the second trading period.

It could be argued that a major share of the cumulative surplus resulted from

the observed and estimated inflow of offsets from the CDM and JI and the re-

spective CER or ERU prices could work as a bottom line for the price decrease

for EUAs. However, Figure 10 indicates that the spread between EUA and CER

prices has been rather constant during the last three years. For 2012 deliveries,

the difference between EU ETS allowances and offsets from the CDM was in a

comparatively narrow range from € 3 to 5. With a view to the (future) supply of

CERs (Table 15), which exceeds significantly the entitlements for use in the EU

ETS, the availability of CERs cannot be assumed to be a price stopper for EUA

prices.


- 52 -

Table 15 Projection for the supply of Certified Emission Reductions (CERs) eligi-

ble under EU ETS rules from 2013 to 2020

Available offsets from

CDM projects eligible

under EU ETS rules

from 2013

mln CER

From existing least-developed country (LDC) projects produced before 2013 3

produced 2013-2020 116

From future least-developed country (LDC) projects May 2012 to end 2020 100

From existing allowed registered projects in non-LDC countries 2,230

From new allowed registered projects in non-LDC countries May 2012 to end 2012 100

Total 2,549

Memo items

From existing higher efficiency coal power plants 200

From existing hydro power projects >20 MW 1,300 Source: UNEP Risoe CDM/JI Pipeline Analysis and Database, May 1st 2012

The recent EUA price could be a result of medium-term hedging strategies.

Against the background of a steadily decreasing cap, according to the recent

legislation based on a linear reduction factor of 1.74 % annually, there will be a

point in time when the allowance surplus turns into a scarcity, additional and

significant emission reduction will be necessary and the EUA price formation

will return to fundamentals. In this case, investors could be interested in acquir-

ing allowances at the recent low price levels and bank them until the need for

additional emission abatement triggers higher EUA prices again. Operators with

a long EUA positions could bank EUAs with the expectation of higher prices in

the future. The recent price levels for allowances would result from a discount-

ing of future values of EUAs.

Last but not least, the recent EUA price could already reflect the future option of

increasing the level of ambition of the underlying EU climate policy and as a re-

sult tightened caps and higher or earlier scarcities in the allowance market.

However, this explanation is extremely difficult to validate and the most recent

trends indicate the opposite: Although the debate on adjustments of the EU

ETS cap emerged significantly during the last months, it has not been reflected

by any move in the allowance markets.

Against this background the numerical analysis of price responses to different options

to adjust the EU ETS is based on a rather simple model. According to the second op-

tion discussed above, the recent price depends on three factors:

The point in time when the surplus of allowances turns into scarcity is a key in-

put parameter. The information on this point in time can be derived from the de-

tailed analysis in the previous chapters.

The assumption of the allowance price at this point in time must reflect the fun-

damentals for emission abatement in the subsequent period of time. The range


- 53 -

of recent analysis on this is broad but the range of respective price forecasts for

the time horizon of 2020 shows a comparatively narrow range.

Table 16 shows the EUA prices resulting from the recent modelling for the EU

Energy Roadmap 2050 (CEC 2011d), other analysis (BNEF 2012, Deutsche

Bank 2011) conclude comparable, scarcity-driven price levels.

Furthermore, the data shown in Table 1 indicate the links between emissions

reduction efforts in the EU ETS and the respective allowance prices. As general

and approximate rules the following rough parameters were derived from the

EU Energy Roadmap 2050 modelling exercises: Emission reduction efforts of

about 20 % (by 2020), compared to 2005, are consistent to prices levels of 15

to 20 €/EUA; emissions reduction efforts of about 30 % (by 2020) refer to price

levels of 20 to 25 €/EUA; emissions reduction efforts of about 40 % (by 2030) to

35 to 40 €/EUA and reduction efforts of about 50 % (by 2030) are consistent

with prices levels of 50 to 60 €/EUA.13

Table 16 Allowance price projections for the EU ETS from the EU Energy

Roadmap 2050, 2020-2040

2020 2030 2040 2020 2030 2040

Reference Scenario 18 40 52 -23% -37% -55%

Current Policy Initiative Scenario 15 32 49 -28% -38% -52%

High Efficiency Scenario 15 25 87 -32% -51% -74%

High Renewables Scenario 25 35 92 -32% -56% -76%

High Nuclear / Delayed CCS Scenario 25 55 190 -32% -54% -76%

High CCS / Low Nuclear Scenario 20 63 100 -30% -51% -74%

Diversified Supply Options Scenario 25 52 95 -32% -53% -74%

Note: The reduction efforts refer to stationary sources regulated by the EU ETS.

€(2008) / EUA compared to 2005

EUA price Reduction effort

Source: European Commission

For the discount factor a wide range of options exists. Figure 11 shows the in-

teraction of different discount factors, three different fundamentally based

abatement cost levels, different periods of time for the oversupply of allowances

and the recent range of allowance prices. For a period of 11 years until the

oversupply of allowances in the EU ETS will be removed under the recent legis-

lation, the recent price levels would be consistent with a 10 % discount rate and

a scarcity-based price level of 25 €/EUA or a 12.5 % discount rate and a future

price of 20 €/EUA or a 7.5 % discount rate and future price of 30 €/EUA.

13

It should be highlighted that the CO2 prices are significantly determined by the range and the intensity of complementary measures to the EU ETS. In the High Efficiency and the High Renewables Scenario of the analysis for the EU Energy Roadmap 2050 the role of such complementary policies is more significant than in the other scenarios. Consequently the al-lowance prices for these scenarios are lower compared to the other scenarios.


- 54 -

Figure 11 Discounted CO2 allowance prices for different periods of oversupply

0

5

10

15

20

25

30

35

0 5 10 15 20 25

€/

EU

A

Years of EUA oversupply

20 €/t CO2 @ 7.5%

20 €/t CO2 @ 10.0%

20 €/t CO2 @ 12.5%

25 €/t CO2 @ 7.5%

25 €/t CO2 @ 10.0%

25 €/t CO2 @ 12.5%

30 €/t CO2 @ 7.5%

30 €/t CO2 @ 10.0%

30 €/t CO2 @ 12.5%

EUA price 2013

Best guess for the duration of

the surplus in the EU ETS

without intervention


Based on these classifications, the numerical analysis is based on the following as-

sumptions:

Future scarcity-based allowance price levels from 20 to 30 €/EUA, the lower

range representing the lower (recent) ambition level and the upper range re-

flecting tighter caps (e.g. in the framework of a 25 % domestic reduction target

for the total greenhouse gas emissions of the EU).

Discount rates of 7.5 % for the 20 €/EUA trajectory and 10 % for the higher

range of scarcity-based allowance prices.

The model calculates EUA prices at 2012 prices levels, depending on the point in time

when the surplus of allowances turns into a scarcity of allowances, compared to base-

line emissions.


- 55 -

6.4.2 Results of the allowance price effects estimates

Table 17 provides an overview of the results of the numerical analysis based on the

modelling approach presented in the previous chapter.

Table 17 CO2 allowance price effects of the different options, 2013 and 2020

Remarks

2013 2020

Recent legislation: Base case (2013 future) 7.90 14.30…19.50

Base case &

set aside (2013/2016) reintroduced 2017/20207.90 14.30…19.50

Price effects tend to the

lower range

Base case &

set aside (2013/2016) reintroduced 2023/202610.50…11.20 18.40…28.80

ditto, prices are slightly

dampend after 2020

LRF 2.25% from 2014 8.70…8.90 15.60…22.30

LRF 2.25% from 2014 &


LRF 2.25% from 2014 &


LRF 2.25% from 2014 (incl. Aviation) &


Price effects tend to the

upper range

ditto, prices are slightly

dampend after 2020

Projected EUA price

€(2012) / EUA


From these modelling results some key lessons can be derived from different types of

interventions:

If the market participants believe that the set aside of allowances will not re-

enter the market for a longer time or lead to retirement of the respective allow-

ances and will not ultimately be complemented with tighter caps, the price effect

of such a set aside strategy will be negligible.

If there is a clear announcement by lawmakers or a belief by the market partici-

pants that the set aside will not be brought back to the market before a

10 years’ time and no tighter cap will be implemented for the foreseeable future,

the short-term price effect (2013) will lead to higher prices of approx.

2.50 €/EUA and approx. 4 €/EUA for 2020. If the set aside is not cancelled and

the respective allowances were to re-enter the market after a period of 10

years, it would lead to (slightly) dampened EU prices for the period beyond

2020.

If no set aside strategy is implemented and only the cap is tightened based on a

linear reduction factor of 2.25 % annually from 2014 onwards, the price effect in

2013 would be very low (1 €/EUA at maximum) and necessarily more significant

(2 to 3 €/EUA) for 2020.

If the set aside is brought back to the market before 2020 this would trigger no

additional price effects even for the more ambitious linear reduction factor.


- 56 -

If a more long-term set aside is combined with a tighter cap the price effects for

2013 will be significant for both the 2013 (4.50 €/EUA) and the 2020 (approx.

15 €/EUA) time horizon. Again, if the set aside is not cancelled and the respec-

tive allowances were to re-enter the market after a period of 10 years, this

would lead to (slightly) dampened EU prices for the period beyond 2020.

A tighter cap for the aviation sector within the EU ETS would further increase

the EUA price by € 0.50.

The ranges shown in Table 17 also indicate that the price effects are obviously subject

to uncertainties, depending on the parametrization of the model, which reflects the dif-

ferent assumptions on future trends of key fundamentals for abatement costs:

future price levels and price patterns for fuels and energy (especially the ratio

between natural gas and hard coal prices as well the ratio between hard coal

and lignite in the continental European market); and

future investment price levels for installations and plants regulated by the EU

ETS.

However, some sensitivity analysis shows that the central results described above are

rather robust.

Last but not least, it should be pointed out that the increase of the linear reduction fac-

tor from 1.74 % to 2.25 % (reflected by a scarcity-based allowance price increase from

€ 20 to 30 by the time when scarcity would occur) is complemented by the assumption,

that no additional entitlements for the use of offsets from CDM or JI would be intro-

duced. Otherwise the oversupply of allowances would be maintained for a longer time

and the allowance price effects indicated above would significantly overestimate the

EUA price increase.


- 57 -

7 More ambitious greenhouse gas emission reduction

targets for the EU: Analysis of implications for the EU

ETS

The analysis presented in chapter 6 is based on a specific starting point: two prominent

proposals from the European Parliament on a set aside and an adjustment of the linear

reduction factor from 1.74 to 2.25 %. The key motivation behind these proposals is to

fix the recent problems in the EU ETS.

However, this approach is only one of a broad range of alternative or complementary

options to provide a solution to the recent problems in the EU ETS. This chapter pre-

sents analysis which is based on a different starting point. In a back-casting exercise

two options were analysed on their implications on the EU ETS, both options are based

on stronger ambitions of the EU climate policy and the corresponding targets:

For the first option it was assumed that the EU would strengthen the overall

greenhouse gas emissions reduction target from 20 % to 25 % by 2020, com-

pared to 1990 levels. However, this option also includes a change in the archi-

tecture of the target. Whereas the existing 20 % target includes the (restricted)

use of emission reduction credits from abroad, the 25 % emissions reduction

target is understood as a domestic reduction target. In other words, the 25 %

emissions reduction should be achieved exclusively within the EU.

For the second option the domestic target for the EU is set at 30 % by 2020.

This means that emitters in the EU must reduce their emissions in total by 30 %

for the period from 1990 to 2020.

As for the whole analysis in this study, these targets are understood as reduction goals

for all greenhouse gases, including the whole aviation sector14 but excluding the emis-

sions from land use, land use change and forestry.

As the focus of the analysis presented in this chapter is on domestic emission reduc-

tions, the first step is to quantify the domestic emission reductions that will be achieved

by the Climate and Energy Package agreed in 2008:

The starting point of the analysis is the total emissions reduction achieved from

1990 to 2005, including the emission trends from aviation.

The total contribution of the EU ETS is defined by the cap. The use of emission

reduction credits from abroad must be separated to differentiate between total

14

In the Climate and Energy Package emissions from international aviation have been includ-ed in the reduction target of the EU-27. In order to address this, the 2020 targets discussed in this chapter are compared to 1990 emissions of the EU-27 including emissions from inter-national aviation (flights departing from the EU as reported in the inventories). In order to compare the contribution of different sectors to achieving the emissions reduction target all emission reductions are expressed as a share of 1990 emissions including international aviation.


- 58 -

and domestic emission reduction efforts. However, this data is available and

transparent from the entitlements for the use of CERs and ERUs within the EU

ETS.

The legally binding targets for the emission sources not regulated by the EU

ETS (effort sharing targets) are also defined. The domestic contributions must

also be separated from the total emission reduction efforts for these sectors.

The maximum amount of offsets from CDM and JI which could be used by the

Member States for their contribution to the effort sharing targets is also legally

defined and transparent.

Figure 12 Total and domestic emission reductions according to the 2008 Climate

and Energy Package, 2020

-25%

-20%

-15%

-10%

-5%

0%

Scope of KyotoProtocol

Internationalaviation

EU ETS(LRF 1.74%)

Non-ETSemission limits

EU ETSse of CDM & JI

Non-ETSuse of CDM & JI

Historic trend 1990-2005 Climate and Energy Package 2020

red

ucti

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s c

om

pa

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to

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tal

19

90

em

iss

ion

s


Figure 12 provides an overview of the different contributions to the emission reductions

for the period from 1990 to 2020:

The EU-27 had achieved an emission reduction of 8 % below 1990 levels by

2005, based on the accounting rules of the Kyoto Protocol which exclude emis-

sions from international aviation. Taking into account the significantly increased

emissions from international aviation, the total emissions reduction from 1990 to

2005 decreases to 7 %.

With the agreed targets for the EU ETS and the non-ETS emission limits laid

down in the Effort Sharing Decision, the EU-27 will achieve an emission reduc-

tion of 20 % below 1990 levels by 2020. The EU ETS contributes approx. 9 per-

centage points of emissions reduction, based on the linear reduction factor of


- 59 -

1.74 %. The sectors not regulated by the EU ETS have to achieve an additional

emission reduction of about 4 percentage points.

However, the additional emission reductions from 2005 to 2020 also include the

use of emissions reduction credits from CDM and JI. Total offset use in the EU

ETS from 2008 to 2020 can be estimated at 1,622 million CERs or ERUs. This

is an equivalent of 2 percentage points in the total emission reduction.15 For the

non-ETS sectors the use of offsets is limited to 3 or 4 % of the 2005 non-ETS

emissions (EU 2009b). Expressed as the contribution to the 2020 target it is

equivalent to approx. 1 percentage point of the total emission reduction.16

With respect to these contributions the domestic emission reduction effort from the

2008 Energy and Climate Package amounts to 17 % by 2020, compared to the 1990

levels.

The adjustments for the EU ETS analysed in the previous chapter obviously has an

impact on the emission reductions by 2020.

An increase of the linear reduction factor from 1.74 to 2.25 % increases the

emission reduction effort by 2020, which equals an additional reduction of ap-

prox. 1.5 percentage points.

If the set aside of 1,400 million EUAs is calculated as an average annual effort

for 2013 to 2020, it equals an emission reduction of about 3 percentage points.

This assumption is based on a long-term approach for the set aside, which

means that the set aside or parts of it are not introduced to the market before

2020.

Under the assumption that these additional provisions for the EU ETS will not be com-

plemented by additional efforts in the non-ETS sectors, the total emissions reduction

from 1990 to 2020 would amount to almost 24 % in total and approx. 21 % at the do-

mestic level. However, if the set aside is not retired after 2020 it would result in a need

for additional emission reduction efforts for the decade beyond 2020 (e.g. an increased

reduction effort of 2.5 percentage points in 2030).

In this context two additional provisions for the EU ETS and the non-ETS sectors were

analysed:

The EU commits to a 25 % domestic emission reduction by 2020, the share of

the EU ETS in the additional reduction efforts would continue to be two thirds of

15

In order to quantify the contribution of offsets to emission reductions in 2020 the total allowed offset use in the EU ETS was calculated as the annual average use for the 13 years from 2008 to 2020.

16 According to the recent policies it was assumed that Germany, the UK and France will not

use offsets to reach their non-ETS targets. Therefore, the potential use of offsets by these countries was not taken into account in this calculation. The use of offsets for the remaining countries was considered as the annual average of the total allowed use for the period from 2013 to 2020.


- 60 -

the total additional effort (CEC 2011d+e, Öko-Institut 2011) and a set aside of

1,400 million EUA would be separated from the market and not introduced be-

fore 2020.

The EU sets a target of a 30 % domestic emission reduction by 2020, the share

of the EU ETS in the additional reduction efforts would also continue to be two

thirds (CEC 2011d+e, Öko-Institut 2011) of the total additional effort and a set

aside of 1,400 million EUA would be separated from the market and not intro-

duced before 2020.

Based on these assumptions the implications for the EU ETS can be derived with a

back-casting approach.

For the case of the 25 % domestic emission reduction the linear reduction factor

must be increased to 2.6 % from 2014 onwards. This represents an annual de-

crease of the cap by 57 million EUA. Without consideration of the set aside the

scope-adjusted cap of the EU ETS would represent an emission reduction of

27 % from 2005 to 2020 and the complete abatement of greenhouse gas emis-

sions by 2050.

For the case of the 30 % domestic emission reduction goal the implicit linear re-

duction factor is 3.9 % from 2014 onwards, representing an annual decrease of

the cap by 86 million EUA. Without the effects of the set aside this would result

in an emission reduction of 36 % from 2005 to 2020. The emissions from

sources regulated by the EU ETS must be completely abated by 2038, in a pe-

riod of 25 years from now.

Figure 13 Adjustments of the ETS and the switch to more ambitious EU targets for

greenhouse gas emission reductions in 2020

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

by 2005 Package 2008 Set aside LRF 2.6% Set aside LRF 3.9%

reductions Energy ETS Non-ETS ETS Non-ETS

Emission Climate and Domestic 25% target (compared to 1990) Domestic 30% target (compared to 1990)

red

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- 61 -

Figure 13 provides an overview of the different contributions to the overall domestic

reduction. Starting from a domestic emissions reduction of about 17 % compared to

1990 levels, the emissions reductions would be allocated as follows:

The set aside would again represent a contribution of 3 percentage points

(based on the emission levels of 1990);

The increase of the linear reduction factor from 1.74 to 2.6 % would represent

an emission reduction of about 2 percentage points (referring to the total emis-

sions in 1990). Depending on the emission reduction delivered by the EU ETS

the reduction efforts in the non-ETS sectors (buildings, transport, agriculture,

waste management etc.) would amount to 2.5 percentage points;

If the linear reduction factor is increased to 3.9 % the respective emission re-

duction amounts to 6 percentage points by 2020. Accordingly the contribution of

the non-ETS sectors increases to 4.5 percentage points.

With a set aside in the EU ETS of 1,400 million EUA, an increase of the linear reduc-

tion factor from 1.74 to 2.6 % for the EU ETS cap and increased efforts in the non-ETS

sectors the EU would be able to achieve a domestic emission reduction of 25 % below

1990 levels by 2020.17 The additional efforts in the non-ETS sectors represent one third

of the additional reduction effort to step up to a more ambitious reduction target of 25 %

domestically. With an increased linear reduction factor of 3.9 % for the cap of the EU

ETS and consistently increased efforts in the non-ETS sectors, the EU would able to

achieve domestic emission reduction of 30 % below 1990 levels by 2020.18

However, it should be carefully considered that the emissions reductions from the set

aside of about 3 percentage points of the total target of 25 or 30 % are non-permanent

if the set aside is not retired. Otherwise the reintroduction of the set aside (after 2020)

to the market would have to be compensated in the next decade by additional efforts.

The significantly tightened caps for the EU would obviously have price effects in the

market for emission allowances. Considering the efforts and the methodological ap-

proach used in this study two reflections are necessary:

The model and its parametrization can be used for the case of a linear reduction

factor of 2.6 % (consistent to the domestic reduction target of 25 %) for the

short-term price effects as well as the price projection for 2020.

For the case of an increase of the linear reduction factor to 3.9 % the model can

only be used for the estimation of the rather short-term price effects. For the

17

The reduction effort of the set aside in 2020 is calculated by distributing the total size of the set aside (1,400 million EUA) equally to the eight years of the third trading period. An in-crease of the linear reduction factor to 2.6 % delivers an emission reduction of 133 million t CO2 in 2020. Expressed as a share of 1990 emissions including international aviation this translates into an emission reduction of 2.3 percentage points in 2020.

18 Again the non-ETS sectors cover one third of the additional reduction effort to step up to a

more ambitious reduction target of 30 %.


- 62 -

longer-term projection the underlying assumption of scarcity-based EU prices in

the range of € 20 to 30 is not applicable in the framework of a cap trajectory that

leads to full decarbonisation of the EU ETS-regulated stationary sources within

25 years. Therefore and because of the wide range of possible policy specifica-

tions for this level of ambition (e.g. the contributions deriving from complemen-

tary policies to the EU ETS), the projection of EU prices is based on a rough

guess based on the data referred to in Table 16.

Table 18 Key implications for the EU ETS from the back-casting calculations for

the 25 % and 30 % domestic reduction targets by 2020

Base casec

25% below 1990 30% below 1990

Linear reduction factor

from 2014 onwards1.74% 2.6% 3.9%

mln EUA 1,820 1,687 1,487

compared to 2005 -21.6% -27.3% -35.9%

Scarcity of allowances from 2024/2025 2019/2020 2017

EUA price effectsb

2013 €(2012)/EUA 7.90 12.10…13.40 13.30…15.30

2020 €(2012)/EUA 14.30…19.50 19.70…32.00 35.00…40.00e

Domestic target by 2020d

Cap in 2020

(stationary EU ETS III

scope)a

Notes: a The cap data do not consider the effects from the set aside. - b The EUA price effects consider a set aside

of 1,400 mln EUA in 2013/2016 which is not reintroduced before 2020. - c The EUA price effects tend to the lower

range. - d The EUA price effects tend to the upper range. - e The EUA price effect is a rough estimate based on a

range of other studies Source: Calculations by Öko-Institut

Table 18 summarizes some of the key results from the analysis for the EU ETS. The

significantly increased reduction efforts (from 21.6 % below 2005 levels to 27.3 % and

35.9 %) will accelerate the cutback of the allowance surplus in the EU ETS and trigger

significant price increases for allowances. Although the caps are significantly tightened

the immediate price reactions will be limited; the prices for 2013 increase in the range

of 5 to 6 €/EUA. However, the long-term price effects must be significant if the linear

reduction factors should be increased from 1.74 % to 2.6 or 3.9 %. In 2020 the EUA

prices could increase to more than 30 €/EUA in the framework of the 25 % domestic

target and to significantly higher levels for the 30 % domestic target.

All in all, the analysis shows that the most prominent proposals on EU ETS adjust-

ments are not fully in line with a 25 or 30 % domestic reduction target for the EU. A

stand-alone package for the EU ETS, consisting of a set aside and an increase of the

linear reduction factor from 1.74 to 2.25 % would only provide a domestic reduction of

about 21 %. If the linear reduction factor were increased to 2.6 % and complementary

efforts made in the non-ETS sectors, the 25 % domestic reduction target could be

achieved. The same situation applies for a linear reduction factor of 3.9 % and the

30 % domestic target. The stabilizing effects for the EU prices would be significant for

all options in the short term and much more important in the longer term.


- 63 -

8 Summary and conclusions

EU energy and climate policy faces manifold challenges. The debate on tougher emis-

sions reduction targets for 2020 is emerging, the need for an integrated framework and

long-term targets as well as consistent and interim targets for 2020 and 2030 is becom-

ing obvious and the adjustments to the EU ETS seem to be indispensable to preserve

its role as a central pillar of the EU’s energy and climate policy mix.

The EU is on its way to meeting its recent greenhouse gas emission targets for 2020.

In 2010 the total greenhouse gas emissions were at a level of 14 % below the 1990

levels. Including the contributions from the entitlements for the use of emission reduc-

tion credits from abroad, namely the Clean Development Mechanism (CDM) and Joint

Implementation (JI), in the EU ETS the total compliance effort increases to 16 %. The

foreseeable use of foreign credits by the governments to comply with their non-ETS

emission reductions adds another percentage point; the total progress in compliance to

the 20 % reduction target in 2020 totals 17 %. The remaining effort of 3 % is theoreti-

cally already gap-filled with the cap of the EU ETS by 2020.

The current situation is also challenging for the EU ETS, which is facing significantly

falling allowance prices. These price trends and the emerging investment needs in the

European power markets raise the question of the fundamental reasons for this price

development as well as the concern of whether the EU ETS will be able to maintain its

role as a central pillar of climate policy in the EU. The key reason is the massive supply

of emission allowances and emission reduction credits, which exceeds the demand

significantly. From 2008 to 2011 a surplus of about 950 million allowances was accu-

mulated and creates major impacts on the markets. A detailed analysis of demand and

supply indicates that this surplus of supply will continue for the next decade or more if

no adjustments to the EU ETS are implemented. The major reasons for the massive

supply are the huge entitlements for the use of external emission reduction credits from

CDM and JI as well as the long-term impacts of the financial and economic crisis,

which changed the baseline emission trend and consequently reduced the emission

reduction effort built into the EU ETS in its actual parameterization. By 2020 the major

share of the remaining surplus19 will stem from the inflow of external credits and a

smaller part can be attributed to the economic crisis. Only a minor contribution to the

surplus results from the support for renewable energy sources with complementary

policies to the EU ETS. The recently projected contribution of renewable energies to

emissions reduction in the sectors regulated by the EU ETS matches more or less per-

fectly with the assumptions made for the cap-setting in the integrated analysis for the

Energy and Climate Package in 2008. However, this matching results from diverging

trends for the deployment of different sources of power generation from renewable en-

19

Purchases of EUAs from the aviation sector that will reduce the surplus are not yet sub-stracted here.


- 64 -

ergies, which are coincidently compensating each other. This coincidence must not

necessarily also occur in the future, i.e. for the time horizon beyond 2020.

However, the need for some adjustments of the parametrization of the EU ETS is

emerging. Two approaches were used to analyse potential interventions.

The first approach refers to a prominent proposal in the recent debate, put forward by

the European Parliament and consisting of two key elements. This proposal includes

firstly a set aside of 1,400 million allowances and secondly a tighter cap for the EU

ETS, implemented by an increase of the linear reduction factor from a recent 1.74 % to

2.25 % from 2014 onwards.

The second approach starts from a more ambitious emissions reduction target for the

overall greenhouse gas emissions for the EU by 2020, i.e. a reduction of 25 % and

30 % by domestic measures, based on 1990 emission levels. Such overarching emis-

sion reduction targets can be translated into an increase of the linear reduction factor

from 1.74 % to 2.6 % (25 % target domestically) and 3.9 % (30 % target for domestic

emission reductions).

The analysis clearly shows that a significant reduction of the surplus is only possible

with the combination of a set aside and adjustments of the cap by increasing the linear

reduction factor. Stand-alone measures like a set aside on the one hand or the adjust-

ments of the linear reduction factor on the other hand will have only extremely limited

impacts on the surplus for the next decade. However, the effectiveness of both inter-

ventions is subject to some caveats:

A set aside will only have an impact if the market participants believe that the

respective amount allowances will be held back for a sufficient period of time (at

least until the surplus is fully removed) or will be retired.

Tighter caps for the EU ETS will only achieve the intended effects if not com-

plemented by an increase of the entitlements for the use of external credits,

which would increase the surplus again and decrease the allowance prices.

An assessment of the different options with a relatively simple allowance price model

(which nevertheless explains the recent price levels comparatively well) leads to some

key lessons on different types of interventions:

If the market participants believe that the set aside of allowances will re-enter

the market or will not be retired and will not ultimately be complemented by

tighter caps, the price effect of such a set aside strategy will be negligible.

If there is a clear announcement by lawmakers or a belief by the market partici-

pants that the set aside will not be brought back to the market before a 10 year

time period has passed and no tighter cap will be implemented for the foresee-

able future, the short-term price effect (2013) will lead to higher prices of ap-

prox. 2.50 €/EUA and approx. 4 €/EUA for 2020. If the set aside is not cancelled

and the respective allowances were to re-enter the market after a period of 10

years, it would lead to (slightly) dampened EU prices for the period beyond

2020.


- 65 -

If only the cap is tightened based on a linear reduction factor of 2.25 % annually

from 2014 onwards, the price effect in 2013 would be very low (1 €/EUA at the

maximum) and necessarily more significant (2 to 3 €/EUA) for 2020.

If the set aside is brought back to the market before 2020 it would trigger no ad-

ditional price effects even for the more ambitious linear reduction factor.

If a more long-term set aside is combined with a tighter linear reduction factor of

2.25 %, the price effects for 2013 will be significant for both the 2013

(4.50 €/EUA) and the 2020 (approximately 15 €/EUA) time horizon. Again, if the

set aside is not cancelled and the respective allowances were to re-enter the

market in the medium term, it would lead to (slightly) dampened EU prices in fu-

ture.

A tighter cap for aviation (applying the linear reduction factor of 2.25 % also to

the sub-cap for aviation) would further increase the EUA price by € 0.50.

The EUA price effects of a set aside, not re-entering the market before 2020,

and a tighter cap based on an increase of the linear reduction factor from

1.74 % to 2.6 % could increase the price in 2013 by approx. 5 €/EUA and by up

to 17 €/EUA in 2020.

The combination of a set aside, which is held back for a decade or more or is fi-

nally retired, and an increase of the linear reduction factor from 1.74 % to 3.9 %

from 2014 onwards would lift the EUA price by up to € 7 in 2013 and potentially

by more than € 20 by 2020. However, the uncertainties regarding the assess-

ment of price effects for this option are comparatively high because of specific

modelling issues and the wide range of potential policy specifications for these

kinds of emission reduction trajectories.

Based on this analysis a set of four recommendations can be put forward for adjust-

ments of the EU ETS:

Firstly, a set aside can reduce the allowance surplus within the EU ETS in the short

term. However, the respective amount of allowances should be held back for a period

of a decade or more or retired at the earliest point in time.

Secondly, the long-term cap should be tightened by a significant increase of the linear

reduction factor, preferentially from 2014 onwards. The effective increase is subject to

fundamental political decisions on the overall emission reduction targets. However, an

increase of the linear reduction factor to less than 2.6 % will be not consistent with

overall targets of a 25 % domestic emission reduction and a factor of less than 3.9 %

will not be consistent with an overarching target of 30 % domestic action by 2020.

Thirdly, no additional entitlements for the use of external emission reduction credits

should be created in the process of tightening the EU ETS cap.

Fourthly, the implementation of high impact complementary policies (e.g. the impact of

the upcoming Energy Efficiency Directive on emissions in the EU ETS sectors), a long-

lasting change in fundamental drivers for baseline emissions (e.g. a significantly lower


- 66 -

GDP growth for a longer period) or other changes in the regulatory framework (e.g. the

discontinuation of significant parts of the aviation sector as net buyers in the market)

should be reflected by a strictly rule-based and high-threshold provision to lower the

cap in the EU ETS.

These kinds of structural improvements could help to preserve the key role of the EU

ETS in an enabling policy mix for ambitious, effective and efficient climate policy.


- 67 -

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Contacts: Hauke Hermann

Felix Chr. Matthes Schicklerstrasse 5-7

D-10179 Berlin Tel.: +49-(0)30-40 50 85-380

[email protected] www.oeko.de

Greenpeace Germany Contact:

Stefan Krug Marienstrasse 19-20

D-10117 Berlin Tel: +49-(0)30-308899-20

[email protected] www.greenpeace.de

Greenpeace EU Unit

Contact: Joris den Blanken

Belliardstraat 199 Rue Belliard B-1040 Brussels

Tel: +32-(0)2-2741919 [email protected]

www.greenpeace.org/eu-unit/en/

WWF Germany Contacts:

Regine Günther Juliette de Grandpré Reinhardtstrasse 14

D-10117 Berlin Tel: +49-(0)30-311777-223

[email protected] www.wwf.de

WWF European Policy Office

Contact: Sam Van Den Plas

168 avenue de Tervuren B-1150 Brussels

Tel: +32 (0)2-7400932 [email protected]

www.wwf.eu

Berlin, June 2012

mailto:[email protected]

http://www.oeko.de/


http://www.greenpeace.de/


http://www.greenpeace.org/eu-unit/en/


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Date post:	03-Feb-2022
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Strengthening the European Union Emissions Trading Scheme by Raising Climate Ambition. Facts

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